Since our first report on Home Capital Group (OTC:HMCBF) (HCG.TO), the company has made a point of addressing at least some portions of the allegations we have put forward.
Given the company has consistently responded to our allegations, we expect this trend to continue on tomorrow's earnings call.
We continue to believe that the market is wildly underestimating the risks present in Home Capital Group's business model that is showing obvious signs of deterioration behind the scenes.
In this article, we highlight some of the key issues facing Home Capital Group in 2017 that we think should serve as the foundation for discussion on tomorrow's Home Capital Group earnings call.
We split this report into three parts. First, we address looming funding stress at Home Capital Group, including recent news that has gone underreported regarding Home Capital Group's strained funding situation. Second, we address a series of undisclosed recent senior executive departures. Finally, we raise the topic of OFSI and its involvement with Home Capital Group, a topic first raised by Marc Cohodes in a BNN interview.
Part 1: Funding Stress Has Begun
Bank regulators across the globe have consistently been uncomfortable with high concentrations of brokered-deposits for obvious reasons - this type of funding tends to walk out the door first in times of crisis. Banks that are perceived to be riskier must pay higher deposit rates, and therefore face higher risk of run in times of crisis.
In the course of our ongoing research into Home Capital Group, we had not yet focused on the company's funding situation. We have always known that a key risk to Home Capital Group is their broker-sponsored deposits. But given that the Canadian housing market at face value remains stable, we did NOT think HCG could already be facing funding stress.
How wrong we were…
With HCG facing a so-called nonexistent loss history (see the 3 bps of provisioning in the last quarter) and paying out an attractive deposit premium, at face value one would think that HCG would be easily able to attain a steady stream of funding from yield-starved investors seeking to earn higher yields without taking on too much incremental risk.
The recent Home Capital Group dividend reinvestment plan ("DRIP") announcement below, therefore, piqued our curiosity.
After paying, maintaining and raising the cash dividend since at least 1999, why did the company all of a sudden decide to give shareholders the option of getting paid-in-kind? We keep hearing that HCG is not just adequately capitalized, but that it is actually overcapitalized. Bulls we speak to want the company to buy back more stock, increase the dividend, and even do another Dutch Auction Tender like the one from last year. The "liquidity preserving" move of installing a DRIP plan seems to be at odds with a company that is purportedly flush with liquidity.
We have seen the DRIP move before, from companies that are trying to shore up liquidity without raising obvious red flags. HCG's decision to install a DRIP plan made us wonder - could something be wrong with HCG's deposit base even while there are only limited signs of any cracks in the Canadian housing market?
Before we show you evidence of deposit flight, let's first take a look at the company's own disclosures from last quarter.
Source: Friendly Bear Analysis and HCG public filings
As you can see, HCG had significant trouble attracting and maintaining brokered GICs (Guaranteed Investment Contracts) last quarter, despite offering higher yields than the big banks do.
For a financial company already running a fairly aggressive loan to deposit ratio, this is a troubling sign.
We, therefore, started making calls in the market to figure out what is going on with HCG deposits. That is when we stumbled upon the following flyer:
Source: Canaccord Genuity Wealth Management Announcement Retrieved by The Friendly Bear investigators
We felt the need to put this text in bold caps:
"THE PRODUCT REVIEW COMMITTEE HAS DETERMINED THAT TWO OF OUR INVESTMENT SAVINGS ACCOUNT PROVIDERS, HOME TRUST AND EQUITABLE BANK, WILL BE REMOVED FROM OUR PLATFORM DUE TO CERTAIN RISKS ASSOCIATED WITH THEIR BUSINESS"
Canaccord Genuity, a large institution that should have a strong pulse for what is happening in the Canadian financial markets, has decided that it has a fiduciary duty to prevent its clients from parking money at Home Capital.
And while we do not have a supporting document like the one above, we have verbally confirmed that similar actions have been taken by both BMO and Scotiabank through calls to both institutions.
Readers probably do not need The Friendly Bear to explain what happens to a financial institution when counterparties and intermediaries begin to question creditworthiness. Just ask the ghosts of Lehman Brothers or Bear Stearns what it's like when your counterparties lose faith. As essentially a non-bank lender, HCG is almost completely reliant on brokered deposits and savings to fund their loan book. Without constant access to these sources of funding, HCG's business model simply does not work.
Non-bank lenders can very quickly death spiral when counterparties stop allowing them to roll over their funding.
Furthermore, the GIC data we present above casts doubt on the company's explanations for why their originations growth has been so anemic for the past several quarters. The company has consistently blamed internal execution issues as the reason that origination growth has remained so anemic. While we do not doubt that HCG has had their internal execution issues, we do wonder how much of the anemic loan growth is actually explained by a lack of funding rather than execution efficiency problems.
At this point, it is probably worth highlighting just how precarious the funding stress we describe above is for HCG. As a reminder, both rating agencies that rate HCG (S&P and DBRS) have the company on negative watch/negative trend. DBRS just reiterated their negative trend view this past month. Perhaps more importantly, S&P rates HCG BBB-, just one notch above non-investment grade.
We therefore wonder - if HCG is really the fortress of stability that the bulls believe, then why does the world's largest rating agency view them a mere step above "junk"?
We set out about looking for other "quality" financial institutions that are similarly rated BBB- by S&P. And that led us to a group of banks that have had their fair share of headlines recently:
Yes… that's right. The banks that have made the "greatest hits" list of potential bank failures for the last 6 months and that have needed government bailout and EU intervention are deemed to have the same ratings profile as Home Capital by the world's premier ratings agency.
We, therefore, leave readers with one parting question.
If funding pressures are already real and counterparties are already pulling, what happens if the Ontario Housing market (~90% of HCG's loan book) has a hiccup?
As essentially a non-banker lender, HCG's business model is just a confidence game.
If Canaccord Genuity is not even willing to sit around and find out what happens in a senior position in Home Capital's capital structure (depositor), why would bulls want to gamble on the junior tranche of the capital structure (shareholder)?
Part 2: More Unreported Executive Departures
We have already demonstrated in our past coverage on Home Capital Group that the company is not exactly a stickler when it comes to making timely disclosures regarding either their mortgage fraud fiasco or related party dealings.
The same can be said of the company's candidness at times of key executive departures. For example, readers may recall the new head of sales, Joe Rosati, who management touted on the Q1 2015 conference call. In case you don't recall, here is the transcript:
Source: Bloomberg transcripts
Now, remember when the company put out a press release to report that Mr. Rosati had left the company only ~1 year after initially being hired?
If you're still searching for the press release, please suspend your search.
Because they did not bother to press release this fact.
It has also now come to our attention that at least THREE and potentially FOUR other key executives appear to have either voluntarily or involuntarily left the company or had their roles restructured. And these three to four individuals represent an even more material event than the unreported resignation noted above.
The apparent departures that we have identified that we believe have not yet been communicated to the market are of Marie Holland, Fariba Rawhani and Gary Wilson. We also note that Anthony Stilo's bio is now missing from the latest version of Home Trust bio page without any explanation.
Marie Holland and Anthony Stilo were in charge of Enterprise Risk Management. The role of Enterprise Risk Management appears to have been created in response to the disruption caused by the mortgage fraud incident. One would then logically assume that these two individuals were responsible for ensuring that the lax underwriting controls that allowed the company to somehow "overlook" $2bn CAD of fraudulent mortgage originations would never happen again. It is probably also safe to assume that OFSI would have been comforted with the appointment of these roles in the course of their oversight of HCG following this episode.
We continue to hear musings from the mortgage broker community that "business as usual" (c. 2015 mortgage fraud era) is alive and well at Home Capital Group. Therefore, we were surprised to see that both senior individuals from Enterprise Risk Management - a group that is charged with clamping down on loose underwriting - have been removed from the company's Directors and Officers page.
We also note that through SEDI filings (that track insiders at Canadian companies), we figured out that both Rawhani (EVP and CIO of Home Trust Company) as well as Wilson (EVP of Underwriting), are no longer listed as insiders as of February 2017 per SEDI records.
For all of our evidence, see before and after below:
Before (Cache Jan 17, 2017)
Source: Retrieved from cached version of Home Trust website from Jan 17, 2017
After (February 6, 2017)
Source: Current Home Trust website
Holland and Stilo are obviously missing from the new version of HCG's page.
While Rawhani and Wilson are still shown on the current Home Trust bios page, SEDI records below suggest both are no longer insiders:
Source: SEDI records
Source: SEDI records
We note that from SEDI records, Holland's end as an insider was dated 1/20/17 giving us higher confidence that she is no longer with the company. Stilo remains a mystery, because his SEDI records have not been updated to show he is no longer an insider, suggesting it is possible his role has been reshuffled but that he remains at the company, albeit no longer on the company's bio page.
There has been no press release from Home Capital Group relating to any of the four individuals identified above. Yet again, Home Capital's management team apparently has decided to not inform the investment community about material events that every investor should be aware of in order to properly assess their investment in HCG.
So what is the TRUTH? Why are people responsible for managing risk and underwriting in the organization either jumping ship or being forced to walk the plank? What else is Home Capital not telling us?
Part 3: OFSI
Before we end this report, we have just one more question for Home Capital. We commend the company for responding to both of our last reports through subsequent press releases. We thank them for doing so and we hope they will oblige us once again.
At an investor conference in the fall, Marc Cohodes proclaimed that HCG is being "staged" by OFSI (for less readers who are less familiar, OFSI is the Office of the Superintendent of Financial Institutions, Home Capital's primary regulator, and effectively the US-equivalent of the Office of the Comptroller of the Currency). We note that this is an uncorroborated belief held by Mr. Cohodes, a legendary and well-known short seller who is known for his research on the Canadian housing market. Both HCG and OFSI declined to comment on Mr. Cohodes' OFSI comment thus far.
You can find a primer on what "staging" means here.
Given the severity of the accusation, we assumed Home Capital would quickly respond and deny the allegation. We realize that if the company is being staged, it may potentially be prohibited from disclosing it. But if it is in fact NOT in a staging process, then one would think management would be free to deny it.
Therefore, we think tomorrow's earnings call will set this matter to rest. If HCG is not being staged, in our view all management has to do tomorrow is come out and deny it on the call.
Given HCG has consistently responded to The Friendly Bear reports, we will interpret silence from HCG tomorrow as a tacit admission that the company is in fact being staged and that management is simply unable or unwilling to discuss the staging process.
To summarize… we recommend that HCG longs ask themselves… do I want to own a financial institution that is:
- Facing funding stress as well-regarded institutions pull deposits
- Losing multiple senior executives (and not disclosing it)
- Potentially (pending the discussion on tomorrow's call) being staged by OFSI
Disclosure: I am/we are short HMCBF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am/we are short Home Capital Group. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. Additional disclosure: This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.
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