Home Capital’s present difficulties might be less about the company’s failings and more about the fundamental doubts surrounding the current business model for Canadian subprime lending, according to a veteran analyst.
In a recent piece for CBC News, markets observer Don Pittis saidthat the alternative lender’s crisis could have been better timed, in the wake of various federal and provincial-level moves to moderate the residential real estate market.
“Anyone worrying about whether a soaring market is a bubble waiting to pop must be on the constant lookout for the trigger that could bring the market down. That’s because, historically, markets can continue to climb while containing the seeds of their own destruction,” Pittis wrote.
“Many of us in the media have been warning of an overheated Canadian property market for so long that homeowners, potential buyers and companies profiting from real estate have every reason to be skeptical,” he added. “In the case of Home Capital, the OSC announcement in April that it was going to proceed against the company may have been the trigger…”
In addition, Pittis explained that several other factors came into play, ultimately resulting into a volatile concoction that is now threatening to spread to the rest of the Canadian financial system.
“One was that [Home Capital] raised its mortgage funding from depositors through its banking division. The other is the curse of all lenders suffering from a run: fractional-reserve lending,” the analyst said. “As Home Capital shares began to slide, it was not just shareholders who began to unload. Depositors began to pull their money out.”
“Underlying Home Capital's decline is its position at the bottom end of the mortgage market,” Pittis emphasized. “Canadians are notoriously good at paying off their mortgages. However, by definition subprime lenders, who give out mortgages to people the big banks have rejected, would be first to suffer in a property downturn.”
Fortunately, not all is lost for the lender, as no signs of a major real estate crash are visible at the moment.
“If the Canadian property market continues to rise, the portfolio of mortgages held by Home Capital is as sound as it was two months ago,” Pittis stated, noting that the company can begin taking the road to recovery if it “can stop the hemorrhaging of its capital.”
“But if the company continues to weaken and fail, leaving its borrowers without an alternative source of money when their mortgages come due, Home Capital could itself become the trigger of larger real estate decline.”
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