Forget Home Capital Group Inc.: Here’s Why You Should Worry About the Banks

Some see the fall of Home Capital Group Inc. (TSX:HCG) as an isolated incident. Some don’t. Here’s why it’s time to worry about Canada’s banks.

| More on:
You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

If you’re a long-time shareholder of Home Capital Group Inc. (TSX:HCG), I feel your pain. In the span of a week, you’ve lost 60% of your capital, rendering seven years of positive returns over the past decade meaningless.

Now that its share price has recovered from hitting a five-year low of $5.68 — a level it hasn’t seen since 2003 — investors can rest a little easier knowing it has a $2 billion line of credit to lean on should it need the cash, albeit at 20% interest.

As a result of the hysteria surrounding Home Capital’s business and corporate governance practices, deposit holders with the alternative mortgage lender have demonstrated ruthless efficiency withdrawing funds from Home Trust, Home Capital Group’s principal operating subsidiary.

It seems a 1% high-interest savings account at a trust company, whose very future is still suspect, isn’t a very attractive offer for most savers; nor should it be.

The other day I was communicating via email with a close friend who works for one of Canada’s big banks and has lots of experience with mortgages; of course, we discussed Home Capital’s situation.

My friend was concerned that the collapse of Home Capital and any other alternative lender could put the banks in the driver seat when it comes to average Canadians accessing mortgages. Furthermore, if those ordinary Canadians don’t fit into the bank’s little boxes, a term my friend used to describe the “perfect” customer, residential real estate prices could finally turn for the worse. contributor Jason Phillips recently discussed what the fall of Home Capital means for the Canadian housing market. He points out that Home Capital accounts for just 1% of the entire Canadian residential mortgage market and of that group of mortgages, only 0.3% is delinquent.

So, you can either view Home Capital’s situation as a one-off, isolated incident or interpret this to be the inevitable beginning of the unraveling of the great Canadian real estate bonanza — a situation where everyone, including the big banks, gets hurt.

I’ve been saying for some time that the CMHC, in conjunction with the Federal Government, is a willing accomplice to the crazy real estate prices paid in Canada’s largest cities. The mortgage insurance rules, despite tweaks to the system in the last few years, have made it easy for buyers to get in on the action. All the while, the CMHC was raking in huge premiums for its insurance.

My biggest issue with mortgage insurance is it puts the ultimate onus on Canadian taxpayers and not the banks who lend the money. The Federal Government has proposed that banks pay part of the insurance deductible, but industry insiders are loath to adopt such a policy, preferring other less disruptive ideas, such as requiring mortgage insurers to buy reinsurance.

It’s going to take a lot of convincing by Bill Morneau and company to get the banks to give up their printing presses.

Beyond the CMHC, my friend mentioned automation as a big reason why housing prices have risen so fast. Here’s a scenario.

You own a house in Hanover, Ontario. The average price in the area is $250,000. So, you list your house for 90 days at $330,000, way above any industry norm for the area. After the listing expires, you take it off the market, deciding to remain in Hanover instead of moving to Prince Edward Country to enjoy the wine lifestyle. When your MPAC assessment arrives the next year, you notice that your house is assessed at $330,000, the same price you’d listed your house only months before.

How does that happen?

It’s the result of automated systems like CMHC’s Emili, which evaluate an application’s likelihood of default. Included in this evaluation is a quantitative-based analysis of the home in question as well as the area where the home is located. There is no human appraisal. Whatever information is fed into the computer dictates Emili’s evaluation.

Why does that matter?

It artificially pushes housing prices higher, which increase the amount you can borrow against your home; lo and behold, Canadians are one of the most indebted nations in the developed world.

It’s not a problem for banks yet. But, if you own bank stocks, you should consider lightening your weighting until the residential mortgage market sorts itself out.

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 Will Ashworth has no position in any stocks mentioned.

More on Bank Stocks

stock data
Stocks for Beginners

Are You Starting a Stock Portfolio? If Yes, Keep It Safe and Simple

First-time investors should keep their stock portfolios safe and simple by holding time-tested, income-producing assets.

Read more »

Hand arranging wood block stacking as step stair with arrow up.
Bank Stocks

The Most Valuable TSX Stock Out There Is up 10% This Month!

This TSX stock is the best value stock out there, expanding even during a downturn and setting itself up from…

Read more »

A person builds a rock tower on a beach.
Dividend Stocks

Change Your Future: What to Hold in a TFSA in 2022

Holding dividend growth stocks in a TFSA long-term can change the financial futures of worried Canadians.

Read more »

work from home
Bank Stocks

Where Should Canadians Invest $500 Right Now? How About the “Best Bank for Your Buck?”

TD Bank (TSX:TD)(NYSE:TD) stock is a Dividend Aristocrat that looks too cheap to ignore as rates surge.

Read more »

Money growing in soil , Business success concept.
Dividend Stocks

Got $4,000? 4 Simple TSX Stocks to Buy Right Now

The macroeconomic environment is tense but investing can be simple. Here are four stocks to buy now and book your…

Read more »

Growth from coins
Dividend Stocks

What’s More Effective: 1 Growth Stock or 1 Dividend Stock for High Returns?

Let's settle the age old debate. If you had invested in a huge growth stock or a solid dividend stock,…

Read more »

Bank sign on traditional europe building facade
Bank Stocks

Why I Prefer Banks to Oil Stocks for 2022’s 2nd Half

Right now, I like bank stocks like Toronto-Dominion Bank (TSX:TD)(NYSE:TD) more than oil stocks.

Read more »

edit Four girl friends withdrawing money from credit card at ATM
Stocks for Beginners

2 Big Bank Stocks to Own for Lifelong Income

These two Big Bank stocks are ideal staple holdings for newbie investors seeking a lifetime of passive income.

Read more »