No. of Recommendations: 4
A look back at the Canadian company, Home Capital Group. Unfortunately, this is not a short post but it may interest some of you. I’ve selected a few excerpts from the documents I found but there’s plenty more reading at each URL below.
Lately, I’ve been watching, listening to, and reading Andrew Brenton from Turtle Creek Asset Management (TCAM) in Canada. Its philosophy and strategy remind me somewhat of Francois Rochon at Giverny Capital and Chris Bloomstran at Semper August Investments Group. TCAM’s 2023 annual letter discussed its successful investment in Home Capital Group (HCG), and I went looking for anything Buffett had mentioned about Berkshire’s investment in HCG as well as anything else I could find on TCAM’s website or elsewhere on the internet.
According to the Financial Post on June 22, 2017, [Note: This is a Canadian publication, so I assume its dollar figures are in Canadian dollars.]
A surprise injection of capital — and cachet — from the world’s most famous investor appears to have marked a major ‘turning point’ in embattled mortgage lender Home Capital Group Inc.’s bid to end a crisis of confidence.
Warren Buffett’s Berkshire Hathaway Inc., said late Wednesday evening it had agreed to indirectly acquire up to $400 million of the Toronto-based company’s common shares in two private placements — giving it a 38.39 per cent equity stake, at a steep discount — and provide a new $2 billion line of credit to its subsidiary, Home Trust….
“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 Buffett, Berkshire’s chairman and chief executive officer, in a statement….
Canada’s biggest alternative mortgage lender has faced eroding market confidence and a partial run on its funding — with depositors withdrawing roughly $2.9 billion of their guaranteed investment certificate and high interest savings account balances from its subsidiary since the end of March — amid allegations of misleading disclosure and executive departures….
The announcement comes one week after it said the company and three of its former executives agreed to pay a total of $30.5 million to settle allegations of misleading disclosure by the Ontario Securities Commission and a class-action lawsuit. Canada’s biggest securities regulator had accused Home Capital and the former executives of misleading investors for months about an internal probe in 2014 and 2015 that led the company to cut ties with 45 brokers over falsified income documentation submitted for some loans.https://financialpost.com/news/fp-street/home-capi...A June 22, 2017, Forbes article said,
That sparked a deposit run on Home Capital. They fund those mortgages by offering high interest savings accounts to depositors. Those depositors started to leave in droves, thus meaning that Home Capital could not fund the mortgages it had already issued. It is, in effect, a run on the bank and that can kill a financial institution. It’s the basic problem inherent in fractional reserve banking in fact. Deposits are usually at sight, or short term at least, while lending is longer term. If the deposits get withdrawn then the bank simply cannot get the money back from those mortgages in order to pay off the depositors. It just runs out of money.https://www.forbes.com/sites/timworstall/2017/06/2...In the afternoon session of Berkshire’s 2019 AGM, an audience member asked about Todd Combs and Ted Weschler’s performance relative to the S&P 500 during their tenures at Berkshire. Buffett responded that one of them was modestly ahead and the other modestly behind. He went on to say that they both had been valuable in many ways, and noted,
What Ted did in terms of the Home Capital Group where we have essentially, in a major way, well, we stabilized a financial institution that was under attack and experiencing runs in Canada. And he did the whole thing….I heard about that on a Monday, and on Wednesday, we put an offer before the company. And previously to that, they probably had dozens and dozens of people combing over them and, meanwhile, they were struggling. And, you know, it was remarkable what he did and I think it’s appreciated in the Toronto area….Crazy that 2 years later, Buffett could remember the days of the week that had been in effect!
For an opposing view from a well-regarded investor, John Hempton of Bronte Capital wrote on April 29, 2017, about the loan HCG secured
prior to the loan it secured from Berkshire,
Home Capital Group is an aggressive Canadian home lender that has hit a very rough patch. If you want a history Twitter will do it well. They have been fighting with Marc Cohodes (a very well known short seller) and you will find a timeline of the unfolding disaster by following Marc’s tweets….
This on the face of it is an extraordinary loan. It is secured by giving the collateral and costs something between 15 and 22.5 percent depending on how much is borrowed….
This is desperation financing. They are securing mortgages (average interest rate below 5 percent) to borrow funds that cost 15 percent or more. The negative carry is huge. A financial institution cannot stay in business under these terms….
I have two words to say to this: fraudulent conveyance. In a rushed deal (one that truly surprised the market) done with undisclosed insiders up to four billion of the collateral and maybe three hundred million dollars of book value has been spirited away. And at basically no risk the recipient of all this largess.
Wow that was audacious. More audacious than just about anything I have ever seen on Wall Street.https://brontecapital.blogspot.com/2017/04/home-ca...Here are a few things I could find from TCAM’s Andrew Brenton:
In the September 30, 2015, edition of Value Investor Insight:
The loan-loss experience has been better than at the big banks, a function of maintaining low loan-to-value ratios and of selectivity in where and when it lends. It stays away from rural areas, for example, preferring cities with homes that are similar to others on the street and can be sold quickly if there is a problem. Because of the lack of recourse to the borrower in Alberta, it’s more cautious with its loan to-value ratios there. In Saskatchewan, where legislation is even friendlier to delinquent borrowers, Home chooses not to lend. That kind of discipline has resulted in 20%-plus returns on equity over time….
There also appears to be specific concern that Home has a high percentage of liar loans and is misrepresenting its credit quality. It didn’t help that there was fraud uncovered recently at a large mortgage brokerage in the Toronto area that appears to have falsified income for some clients that had applied for insured prime mortgages. In that specific case, Home cut off a number of brokers and hasn’t seen any unusual loss or arrears experience on the loans in question. More generally, we trust management and believe the numbers they report, which don’t indicate any real problems with credit quality.https://www.turtlecreek.ca/wp-content/uploads/2020...TCAM’s 2019 annual letter recounted what it had written to clients in mid-2017:
…the run on the bank was not triggered by credit issues at Home Capital. Rather, the public lost faith in the company as a deposit taking institution because of a feeling that there was something wrong. Accusations, confusion and rumours swirled around the company and the belief that this regulated financial institution was a financially strong organization was very quickly replaced with the belief that the company was near collapse. Home Capital certainly made some mistakes that contributed to the loss in confidence (for example, removing its CEO without a replacement lined up), but it ultimately was a combination of many outside forces and factors which destroyed confidence.The letter went on to say [this, written in late 2019 or early 2020],
We were proven correct in our assessment. Within weeks, the company’s board underwent substantial changes with the addition of a number of very experienced financial industry executives. This new board took a series of steps to stabilize the business and restore confidence. First, the company entered into an arrangement to, if necessary, sell-on up to $2 billion of new residential mortgage originations to allow Home Capital to continue to originate and renew mortgages. Second, the company announced the sale of $1.2 billion of commercial mortgages at, essentially, par value, providing not only liquidity but evidence as to the quality of Home Capital’s loan book. Third, the board identified a strong new CEO to lead the company.
At that point, the business had been stabilised and the share price had recovered to the low to mid teens; but the new board believed that the next correct step to take was to issue equity to Berkshire Hathaway at a price slightly below $10 per share. While the company did not need equity capital, the board believed that the endorsement from Warren Buffett would speed the company’s recovery. As the largest shareholder at the time, we strongly supported the board in this decision. We understood Buffett’s endorsement would help restore confidence in the company, and boy did it ever. Interest rates and purchase volumes for the company’s GICs, which had already been improving, quickly returned to pre-crisis levels. At that point, new management was free to set about restoring the company to its market leading position. Today, Home Capital’s book value per share is at an all time high, they are once again the largest provider of Alt-A residential mortgages in Canada and they continue to be very profitable. Moreover, they have been returning meaningful amounts of surplus capital to shareholders through share repurchases. Indeed, the company recently completed its second Substantial Issuer Bid since its funding crisis and has repurchased and cancelled one third of their outstanding shares (including the shares issued to Berkshire in 2017) in the past 13 months. Even with these share repurchases, Home Capital remains overcapitalized and has renewed its Normal Course Issuer Bid.https://www.turtlecreek.ca/wp-content/uploads/2020...In the August 31, 2020, edition of Value Investor Insight, Andrew Brenton said,
Home Capital in mid-2017 faced a funding crisis when it let itself become overly reliant on demand deposits that disappeared in volume when there were rumors – which turned out to be patently false – that the company faced significant credit-quality issues. But the short-term damage was done.
The company needed to sell assets and raise capital to shore up its balance sheet, and the stock fell from the mid-C$20s to a low of around C$6. Of note, one thing Home did was sell a 20% stake in the company to Berkshire Hathaway at C$10 per share, which it ended up buying back 18 months later at around C$16. Berkshire’s involvement had exactly the desired effect, and by the time they stepped out, the crisis had fully passed and the business was operating as well as ever under a reconstituted and upgraded board and management.https://www.turtlecreek.ca/wp-content/uploads/2020...In its 2023 annual letter, TCAM closed out the story as far as it was concerned,
During the year, we removed three companies from the flagship fund. One of them was Home Capital Group which was acquired by Stephen Smith, the co-founder of First National Financial, at a price of approximately $44 per share.This 2023 letter gives a nice multi-page summary of the entire 11-year period of the HCG holding in TCAM’s portfolio, including an interesting recounting of Berkshire’s involvement. It’s great reading for those so inclined.
https://www.turtlecreek.ca/wp-content/uploads/2024...Interested to hear your thoughts about the above and anything else you can recall about the time of Berkshire’s involvement.
