A lot has changed since Warren Buffet
decided to invest in Home Capital and the Canadian housing market.
The billionaire’s company, Berkshire
Hathaway, gave the beleaguered company a $400 million cash infusion along with a
$2 billion line of credit.
Prior to this, Home Capital was in challenging
position, predicated by a damaging allegation in April that the company had
misled its shareholders by disclosing too late that an internal investigation
found evidence of fraud and had cut ties with 45 brokers. Although the alleged
non-disclosure had occurred at least two years prior, and the company’s
business fundamentals were solid, the effect was immediate -- account holders
started to withdraw their money, which resulted in a small “run” on deposits.
Shareholders started to sell,
resulting in a drop in share price. This phenomenon also spread to a few other alternative
lenders in the market, who also saw their share prices fall, for no apparent
reason.
While the Home Capital controversy
shook up the market somewhat, and fed the rumour mill with talk of bubbles,
etc., none of that has come to pass.
Home Capital Overview
Based in Toronto, the publicly-traded
company offers mortgage lending, deposits and credit cards through its principal
subsidiary Home Trust. Ninety per cent of the Home Capital’s business
originates from uninsured mortgage clients who are turned away from traditional
Banks.
As one of Canada’s largest alternative
lenders, the company is an important player in the country’s housing market. A
niche-market lender, Home Trust was one of the go-to lenders that mortgage
brokers used for self-employed borrowers as well as those with some damaged
credit. When the crisis occurred, brokers had to quickly find other mortgage
lenders to take up the slack.
If Home Capital was a bigger player in the
market, there could have been dire consequences. Its mortgage loan portfolio is
approx. $20 billion compared to the $1.1 trillion in residential mortgage loans
of the Big-Six banks.
Was there a real issue?
Most analysts acknowledged that the
underlying fundamentals of the company were steady, although the allegations
created uncertainty. Mike Rizvanovic, an
analyst with the Veritas Investment Research in Toronto said in a Financial
Post interview, “This is a very peculiar situation where Home Capital has no
issues around credit, and no issues with a capital shortfall. Yet they are
being decimated in terms of their viability as an ongoing entity.”
Clearly, Warren Buffet agreed. Not only does his investment put much-needed
capital into Home Capital, it was also a strong endorsement for the company.
“Home Capital’s strong assets, its
ability to originate and underwrite well-performing mortgages, and its leading
position in a growing market sector make this a very attractive investment,”
said Buffet, Berkshire’s chairman and chief executive officer, in a statement.
The Buffet Factor in Action
Almost immediately, Home Capital
shares went up. Other alternative lenders also saw their shares recover. Depositors are coming back, lured
somewhat by an excellent interest rate on deposit accounts.
The other immediate effect was
increased confidence in the Canadian housing market as a whole. Many mortgage
brokers were forced to find alternative lenders when Home Trust depositors
began pulling out their money, leaving the company with a liquidity problem. Mortgage
brokers have now begun referring business to Home Trust again.
Warren Buffet’s investment sends a
strong, positive message about Home Capital and also about Canada’s housing
market.
