Home Capital Group: Details On Its Emergency Line Of Credit

| About: Home Capital (HMCBF)


Home Capital Group announced details about the $2 billion line of credit this morning.

The costs to Home Capital Group are punitive.

The CEO of the reported lender sits on Home Capital Group's board (a major potential conflict of interest).

I continue to recommend staying clear of Home Capital Group.

Yesterday, shares in Home Capital Group (OTCPK:HMCBF) plunged more than 60% on news that it was securing a $2 billion line of credit to backstop withdrawals from its Home Trust High Interest Savings Accounts (HISA). At that point, details about the loan were fairly scarce, although the $100 million fee and reported 10% interest rate demonstrated just how desperate Home Capital was for the emergency funding.

Today, Home Capital shares are experiencing a bit of a dead cat bounce, currently up approximately 15% and regaining a portion of the value they lost yesterday. The firm announced it has hired RBC Capital Markets and BMO Capital Markets to advise on "strategic options". This is not a surprising development - as I speculated yesterday, the firm will have a nearly impossible time regaining enough confidence by depositors to continue originating new mortgages.

As of the beginning of this week, Home Trust (Home Capital's main subsidiary) had approximately $1.4 billion in deposits held high interest savings accounts. As of yesterday, that amount had been nearly cut in half to just over $800 million, according to the company. This stunning decline in deposits is not unexpected, given the news that emerged this week, but speaks to why Home Capital was willing to agree to such punitive terms on the line of credit.

Bloomberg reported today that the Healthcare of Ontario Pension Plan (HOOPP) is behind the $2 billion line of credit ($1 billion of which will be drawn immediately). The costs to Home Capital are as follows:

  • $100 million commitment fee
  • 10% interest rate on outstanding balance
  • 2.5% standby fee on undrawn funds

So, if Home Capital were to borrow $1 billion for the entire 364 day period, the total cost would be approximately $225 million (an effective interest rate of 22.5%). If all $2 billion is required, the total cost jumps to $300 million. For a company with a current market cap of $450 million (CAD), this level of interest expense is staggering.

One more incredible detail about the line of credit for the Bloomberg article:

HOOPP President and Chief Executive Officer Jim Keohane sits on Home Capital's board and is a shareholder of the mortgage lender. Home Capital's external spokesman Boyd Erman declined to comment. Representatives for HOOPP and Keohane didn't return calls seeking comment.

What? The President and CEO of the pension fund that reportedly threw Home Capital a lifeline is a member of the Board of Directors? How on earth is that even close to ethical? The potential conflict of interest here is simply shocking.

Investors looking at buying shares of Home Capital Group here to point to the approximately $18 per share of tangible book value, based on the firm's 2016 financial results. However, it is worthwhile to consider that at least $100 million of that book value disappeared overnight due to the commitment fee on the line of credit, and the book value will continue to decline daily based on the punitive interest rates involved in the emergency financing.

Anyone investing in Home Capital today should be hoping for a quick sale of at least a portion of the firm's mortgages. I anticipate the dividend will be eliminated within the next two weeks, so do not expect the current 15% yield on the shares to be sustainable (this advice should be obvious to any moderately experienced investor).

Still, I am not able to get over the conflict of interest present in the $2 billion line of credit. The whole Home Capital mess, which began with falsified mortgage applications and moved on to alleged improper disclosures just keeps on getting uglier and uglier with each passing day.

I recommend that investors remain on the sidelines. If a sale of the company is successful, there is no guarantee that the price will be meaningfully higher than the current share price. Furthermore Home Capital Group's book value will likely continue to decline each day the line of credit is in place.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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