3 New Developments From Home Capital Group Inc.’s Latest Earnings Release

Here are three new developments from Home Capital Group Inc.’s (TSX:HCG) recent earnings release and quarterly conference call.

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In yet another chapter of the latest saga of Home Capital Group Inc.’s (TSX:HCG) meltdown this year, the company released new information to the public in Thursday’s Q1 2017 earnings release as well as during the earnings conference call on Friday morning.

I’m going to dive into a couple of the most important recent developments which have arisen as of Friday.

Home Capital may not “continue as a going concern”

Likely the most notable development in the company’s communications with outside stakeholders can be found in some of the language company executives used in its most recent earnings release.

“The interim consolidated financial statements for the first quarter ended March 31, 2017 were prepared on a going concern basis; however, management believes that material uncertainty exists regarding the company’s future funding capabilities as a result of reputational concerns that may cast significant doubt upon the company’s ability to continue as a going concern.”

This is the first time the company has initiated such guidance or even hinted at the fact that its current business model is not working and that the company may not continue into the future as a going concern.

On previous conference calls, media events, interviews, and press releases, Home Capital maintained an aura of confidence in its portfolio of mortgages, business model, and deposits; the short-sellers and naysayers who bid down the company’s share price were largely pushed aside in favour of positive guidance moving forward and a narrative involving the strength of Home Capital’s mortgages and business model.

Syndicated loan collateralization confirmed 

In the company’s conference call on Friday, management clarified that the maximum collateralization for the Healthcare of Ontario Pension Plan (HOOPP) syndicated emergency loan of $2 billion is not $4 billion as previously reported (double-collateralized loan), but rather $5.4 billion (nearly triple collateralized) based on two different pools of mortgages used to calculate the collateral ratios.

The company explained that it has two pools of mortgages from which the company can choose to put up as collateral: Pool A and Pool B; Pool A mortgages provide coverage of $0.50 on the dollar (2-t0-1), and Pool B provides coverage of $0.26 on the dollar (nearly 4-t0-1), which is how the company has computed its maximum collateralization level of $5.4 billion.

Home Capital has reconfirmed it has only drawn on Pool A mortgages, and as of the earnings call, its collateralization ratio was still 2-to-1.

What I don’t understand is why discounts of 50% and 74% are needed on a portion of a loan book which has near-zero losses set aside for loan provisions. If the loan book is so “rock solid,” why is Home Capital willing to accept such a large discount for its mortgages?

Replacing this loan a “top priority” 

Home Capital’s newly minted board chair Brenda Eprile has said in a recent interview that its two most important initiatives of late have been a “governance renewal” as well as “looking at [Home Capital’s] funding model,” specifically referencing the short-term emergency loan the company made with HOOPP and other lenders who syndicated the loan to keep the doors open amid a run on the bank’s deposits.

The interest rate on the drawn portion of the loan is approximately 20% — a rate which is not feasible or practical in the near or long term.

Bottom line

Home Capital’s language has changed, and it appears the new board put in place has done a good job of communicating the severity of the risks at play to investors. While I am encouraged by the increased level of transparency, I still believe that the company’s near-zero provision for credit losses for a loan book, which is largely sub-prime, makes no sense in today’s overheated housing market in Canada.

I would like to have seen greater transparency with regards to the risks associated with these loans communicated to investors in the most recent release.

That said, the “rumours” that Home Capital may not continue as a going concern are no longer rumours; the company has used this language itself.

Investors pricing in a Home Capital default or a major Canadian housing market correction as an impossibility will simply need to redo their calculations. Just because the market in Toronto has increased by 32% year over year in April 2017, as Fool contributor Matt Smith pointed out, that doesn’t mean a bubble doesn’t exist; rather, it means the bubble is just simply getting larger.

Stay Foolish, my friends.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Chris MacDonald has no position in any stocks mentioned.

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