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Investment Q&A

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Q: My Question in short:
Can you quantify the change in size of the alternate mortgage lending market due to the recent mortgage regulations changes in Canada? Can you also comment on the quality of said mortgages given that the regulations have essentially raised the bar on the mortgages that the big 5 will write up?

My Question in long form:
I’d appreciate you input on the change in the alternate lending market and any corrections you wish to add to the information I’ve provided.

From my research, there have been three sets of regulations changes to the financial industry in response to the 2008 financial crisis, the Volker rules, Dodd-Frank and Basel I, II, III. From my understanding, the Volker rules limit proprietary trading/derivatives and are thus irrelevant to this subject. The “Dodd-Frank reform” is a sort of blanket US legislation that is being written SEC and rolled out in pieces, some already in effect, until 2018. I believe it will have a direct effect on mortgage quality regulations in the US, but Canadian banks will be able to place there US operations in subsidiaries and thus Canadian operations will be unaffected.

On the other hand, Basel I, II, III and other OSFI policies will have a direct effect on the Canadian mortgage market in a two-fold fashion;
-Bank capital reserves requirements are more stringent from both a quantitative and qualitative measure.
-Rules regarding who qualifies for mortgage insurance have been elevated.

Benjamin Tal recently commented that these new regulations will raises the bar on who qualifies for a big 5 bank mortgage and thus create a new high quality tranche of mortgage business for alternative lenders such as HCG. Would you agree with that hypothesis? I believe the mortgage market is around 1.2 trillion in Canada; do you have an estimate on the size of this tranche of the market? Are there any other alternative lenders similar to HCG that stand to benefit from the change in the market place?


Thanks in advance for answering my question and also for the great research reports you regularly deliver.
Read Answer Asked by Emile on March 06, 2014
Q: J.Hodgins was quoted in the Feb.28 Financial Post saying HCG's "leverage...is currently about 8.5X on its mortgage book. They are moving away from (CMHC) insured mortgages and more toward subprime, and we think this is exactly the wrong time to be doing that." His reco is sell/short on a pair trade though he doesn't say what he's long.

How accurate is what he is stating is Home Capital's strategy, and how important is that leverage number? What for instance are the competition's leverage ratios and what would be a conservative number? I know that Oaken has had a fairly aggressive GIC campaign on the 3 year and less notes over the last few months and I know they like to match the mortgage and GIC terms to reduce rate risk. I've absorbed your previous responses on his BNN appearance and agree with your rationale. Thanks, J.
Read Answer Asked by Jeff on March 03, 2014
Q: Hi Peter: This is a follow-up to Claudette's question regarding Mr. Hodgins' shorting of Home capital Group. As I recall, his argument was that the average house price should be equal to the net present value of a steam of 25 years (I think) of rental payments, and that current house prices are 40% over this level. Hence we have a bubble that will either burst or get deflated by a slow decay in house prices hence less mortgage income for HCG. What do you think of his argument?
Read Answer Asked by Roland on February 27, 2014
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