Monday, May 1, 2017

HOOPP's Home Capital Fiasco?

Michelle Zadikian and Ian Vandaelle of BNN report, Home Capital not a risky investment for us: HOOPP’s Jim Keohane:
Healthcare of Ontario Pension Plan chief executive Jim Keohane doesn’t see Home Capital as a risky investment, despite customers having pulled out hundreds of millions worth of deposits in the past 30 days, leaving observers concerned over how the lender will fund new mortgages.

Keohane, who until Thursday was on Home Capital’s board, says because of the way HOOPP’s $2-billion line of credit provided to Home Capital is structured, the pension fund is protected in the deal.

“The investment itself is backed by a significant pool of mortgages,” he said in an interview on BNN. “So, for every $1 we lend Home Capital, they’re going to provide us with $2 of mortgages as collateral. That’s where we get our protection from.”

Keohane also isn’t concerned about the quality of the underlying mortgages, even those tied to the 45 brokers Home Capital parted ways with after an internal investigation uncovered fraud in 2015.

“Most of those mortgages probably would’ve rolled off the books by now. We feel comfortable with the underlying quality of mortgages, particularly given the protection we have in terms of additional overcollateralization we have,” he said.

“The [housing market] scenario that would have to play out for us to lose money is pretty extreme.”

Keohane’s leadership role at HOOPP and his board position at Home Capital has raised concerns about a conflict of interest.

“Being on Home Capital’s board wasn’t a conflict of interest because HOOPP had no business connection with Home Capital,” said Keohane.

“As soon as it became apparent, when HOOPP was asked to be part of the deal, I recused myself from many board discussions at Home Capital and once we actually engaged in the deal, I resigned from the board.”

Despite the recent concern about the viability of the embattled lender, Keohane doesn’t think Home Capital would’ve folded without HOOPP’s financing, although he does acknowledge the money is a cushion to protect them.

But there are concerns Home Capital may face challenges in its day to day operations.

Andy Nasr, vice president and investment strategist at Sentry Investments, said Home Capital’s increasingly tenuous capital position will present problems when it comes to any further mortgage underwriting.

“You’ve got this $2 billion line of credit which costs a lot of money, and it effectively puts the brakes on your originations,” he said. “While the fundamentals in the existing business still look okay in the sense that we haven’t seen a big run-up in delinquencies, you’re having investors start to worry about the credit quality of the issuer, withdrawing money from those high-interest savings accounts because they’re no longer comfortable with the CDIC backstop,” Nasr told BNN in an interview.

Home Capital’s non-performing loans have held steady at 0.30 per cent of total loans outstanding. Despite the relatively strong performance of the company’s existing loan book, Nasr said this is an issue of investor sentiment given the rising negativity around the company.

“I think that creates a bigger issue because the company’s not really going to be able to grow in a significant fashion until it does calm investors nerves, which I think will be very difficult if there is a class-action lawsuit,” he said. “People look at the stock price, they see the headlines, and they think that Home Capital Group is no longer going to be a going concern, and if that’s the case, then, you’ve got money there, why not take it out and put it somewhere else?”

Nasr said investing in the company at the current time is inadvisable, given said uncertainty surrounding possible lawsuits.

“I’m not sure how anybody can with confidence handicap what this thing is going to be worth if there’s litigation risk.”
If you listen to the BNN interview, HOOPP's CEO Jim Keohane explains why the terms of the deal are extremely favorable for HOOPP stating: "we feel comfortable with the underlying mortgages particularly given the protection we have in terms of the over-collateralization...we have 2.8 times coverage relative to each dollar we lend, so effectively the scenario that would have to play out would need to be extreme." He added: "Home prices would have to drop about 65% in order for us to get back to our principal level."

Jim also addressed concerns that he was in a conflict of interest, stating he was not part of any decision in terms of negotiations between HOOPP and Home Capital, recusing himself from Home Capital's board and then resigning from that board once the loan was announced.

In the event of a liquidation, Jim stated: "We have a security interest in the collateral we have received so we have a right to sell that collateral if we don't get paid and for the balance that's left over, we go into recovery over other creditors."

Jim's comments confirm what I wrote last Thursday when I went over Canada's subprime mortgage collapse and went over HOOPP's investment in the updates and stated this:
There are only two things I will say. Jim Keohane is one of the nicest, most honest pension fund managers I've ever come across. There is no way he didn't inform HOOPP's board of directors of his role prior to entering this transaction and I wouldn't be surprised if he vacated Home Capital's board after entering this deal (I'll put it to you this way, if it wasn't kosher, he would have been fired on the spot).

I mention this because the idiots on Zero Hedge are posting dumb comments on that website calling Jim a crook and that's just pure nonsense. Bloomberg's reporters should also be more careful with what they publish because the optics look bad and they're contributing to this speculation.

More importantly, if you look at the terms of the deal, they are extremely favorable to HOOPP -- ridiculously favorable -- so in the end, this is yet another great deal for HOOPP no matter what happens to Canada's housing market (with these onerous terms, you would need a severe correction of close to 70% in housing prices for HOOPP to lose money on this deal).

Anyway, HOOPP remains the best funded pension plan in Canada. People should read its press releases here, not the garbage written on Zero Hedge or other sites. In fact, HOOPP just released a statement on the Home Trust Company:
The Healthcare of Ontario Pension Plan (HOOPP) today confirmed that it has agreed along with a syndicate of lenders to provide a secured line of credit in the amount of $2-billion dollars to Home Trust Company. Normally HOOPP’s policy is not to disclose information on our investments, however, given the amount of media speculation, we have decided to disclose this information today. Like any investment, this decision was made in the best interest of our members’ financial needs. We have a long history of providing these types of investments as appropriate, risk-balanced vehicles to meet our overall return targets. This investment followed all the appropriate due diligence.
Enough said. It's deals like this one where there is an asymmetric payoff which explains why HOOPP is one of the best pension plans in Canada and the world. Also worth noting in the press release that other investors were part of this deal, so HOOPP didn't go it alone.

[...] even though there could be more upside from these levels, I wouldn't touch shares of Home Capital but it's clear that HOOPP and other lenders entered a great deal. It's also clear that Jim Keohane did the right thing by recusing himself during negotiations and then resigning from Home Capital's board after the deal was made and put his members' best interests first. 
Now, it's critically important that shareholders or Home Capital dip buyers understand that HOOPP's line of credit is a very different and much more secure investment than investing in Home Capital's shares (HCG.TO). As Jim Keohane states, HOOPP has secured rights over other lenders including bondholders.

One thing is for sure, I would NOT use HOOPP's loan to Home Capital as a green light to invest in its shares (HCG.TO). My advice remains the same as last Thursday: don't touch these shares with a ten-foot pole! (you can trade them at your own risk!)

Why? Because as I stated last week, despite the short-term bounce, which is just normal short covering activity after the announcement that Home Capital secured a C$2 billion loan, the long-term chart is broken and suggests more pain ahead (click on image)


Now, let me address some other concerns. Zero Hedge has been covering Toronto's subprime debt bomb and the latest on the bank run there. Over the weekend, it put out a more extensive comment, Panic Bank Run Leaves Canada's Largest Alternative Mortgage Lender On Edge Of Collapse, which made some good and bad points.

In particular, Zero Hedge makes the point that Canada's big banks aren't interested in buying Home Capital which lends to subprime borrowers, a business they aren't allowed to do, but they most certainly would be interested in buying and selling those risky mortgages to investors, something I covered in my comment last week.

But there's no rush for anyone to buy Home Capital. They can wait for it to liquidate and then pick up the scraps for pennies on the dollar (after HOOPP secures its collateral).

Let me address another issue, the perceived conflict of interest Jim Keohane had being CEO of HOOPP and sitting on Home Capital's board.

I had an email exchange with a blog reader who sent me this over the weekend:
If the terms of the deal are "ridiculously favorable" to HOOPP, is it not fair to ask whether Jim Keohane properly discharged his fiduciary duty to the shareholders of Home Capital? Shouldn't he have resigned from the board before this offer was made? FYI, the Home Capital press release announcing a "non binding agreement in principle" with a "major Canadian institutional investor" was dated April 26. The press release saying that Jim Keohane had resigned "today" was the following day, April 27. Thus, it appears that the terms of the deal were negotiated while Jim was still on Home Capital's board and while he was simultaneously representing the conflicting interests of HOOPP and Home Capital.
I replied: "I'm sure it's kosher or else regulators would be all over it. Also, Jim answers to HOOPP's board" (and he would have been fired on the spot if he didn't act in the best interests of HOOPP's members).

I also asked this person: "If Jim Keohane did something illegal, why aren't shareholders suing him? Why aren't regulators slapping a fine on him? Why isn't the HOOPP board hopping mad about this deal? I understand the optics don't look good but we don't have all the details."

This person replied:
Shareholders can't sue until they lose something, i.e. until the episode plays out and they can determine how much the deal cost shareholders. Regulators aren't leveling fines because the regulators, in particular, the OSC, are arguably responsible for the "run" on Home Capital. I suspect the regulators are having second thoughts about their own actions.

The HOOPP board is, I suspect, delighted by the deal as HOOPP is likely to be unjustly enriched by the usurious cost of the loan. Jim will probably get an especially large bonus this year!

Finally, I agree that we don't have all the facts. We also don't know how things will turn out for Home Capital and for HOOPP. But however it turns out, Jim is in an awkward position and he put himself there.
I agreed that Jim put himself in an awkward position and I don't know why he sat on Home Capital's board. To me, this company seems shady, at least according to the short sellers. But at the end of the day, nobody put a gun to Home Capital to accept this loan. Also, there may be other pensions involved in this deal, we just don't know.

[Note: On Monday, Canadian mortgage provider Equitable Group Inc said it received a C$2 billion ($1.47 billion) loan commitment and expected applications to increase in the coming weeks, at a time when rival Home Capital Group's withdrawals are rising. Shares of Equitable Group (EQB.TO), which also reported a 55 percent rise in first-quarter profit, were up 31 percent at C$47.95 in early morning trading on Monday. Don't touch these shares either, short sellers are all over it!]

One thing I can openly admit is I don't like Home Capital and other subprime mortgage lenders who basically lend money to people who can't afford to buy a home and can't get access to credit from Canada's major banks. Their business model works until disaster strikes, leaving many low and middle-income Canadian households out to dry once the bubble bursts.

The problem is the bubble hasn't burst yet for all sorts of reasons I went over in my comment on Canada's real estate mania. Let me paint you my cynical portrait of what is going on:
  • Wealthy foreigners are parking their money in Canada, buying up houses like crazy to obtain Canadian citizenship to have one foot out the door in case something goes wrong, and let's admit it, to evade taxes from their country of residence. You might be surprised (I'm not) to find out that Canada is a safe haven for Malaysian and other money launderers
  • So, you have wealthy foreigners, most with legitimate gains, some without, bidding up home prices on the high and medium end to obtain citizenship, forcing Canadians with stagnant incomes to enter into bidding wars to buy houses. Crooked and unethical Canadian real estate agents using first offers to get a second and higher "blind" offer also fuel these bidding wars on houses (note: if you put an offer on a house, tell your agent to tell the other the agent the seller has four hours to respond or else the offer is null, this way they can't peddle your offer to prompt another prospective buyer to outbid you. Most agents are ethical but there are plenty of unethical sharks, especially in the high-end where competition is fierce and basically controlled by a handful of agents).
  • Canadians looking to buy houses but that can't afford one because their incomes don't support a mortgage from the big banks are increasingly using subprime lenders to secure loans for a home. Some subprime lenders are ethical but many aren't and again, their entire business model is predicated on the fact that Canada's housing market won't collapse and suffer a severe correction, which is pure fantasy. 
  • Canadian policymakers have contributed to this real estate mania, passing bylaws that limit the supply of housing. Regulators have turned a blind eye to it because housing is such an important component of economic activity and so have politicians because they collect more taxes from this real estate mania. 
  • Now that shares of subprime mortgage lenders are collapsing, there is no doubt that everyone --  big banks, subprime lenders, politicians, regulators, the CMHC and the Bank of Canada -- is petrified of what happens when the music stops and Canada's real estate bubble bursts. But for now, they are all hoping the market won't collapse.
That, in a nutshell, covers my macro analysis of the great Canadian real estate market fraud. You can vigorously disagree with me but this is truly how I explain Canada's housing mania.

As far as HOOPP's Jim Keohane sitting on the board of Home Capital, I agree with Carol Hansell's comments in Barbara Shecter's National Post article, ‘Better not to sit in two places’: HOOPP board overlaps raise concerns:
Officials at the Healthcare of Ontario Pension Plan, the large institutional investor behind a $2 billion line of credit extended this week to struggling Home Capital Group Inc., say they were approached Tuesday by the mortgage lender seeking funding.

As soon as that happened, HOOPP chief executive Jim Keohane, who was also on Home Capital’s board of directors, “recused himself and turned the negotiations over to HOOPP staff,” Martin Biefer, a pension fund spokesperson, said Friday.

“They (the staff) made a decision on whether a deal was possible on terms that were favourable to HOOPP,” he said in an interview.

Keohane’s connection to both the borrower and lender led to questions about how the transaction came together, and whether there were any real or perceived conflicts of interest.

The comments from HOOPP on Friday fill in some of the details, and distance Keohane from the decision-making on both sides of the transaction.

Keohane resigned Thursday from Home Capital’s board of directors, which he had joined last year. In a news release issued late Thursday, Home Capital said “it would no longer be appropriate for him to serve as a director given the potential conflicts that might arise from the new relationship.”

The statement also revealed that Home Capital’s chair Kevin Smith had resigned from the board of HOOPP, which invests on behalf of healthcare workers in Ontario.

Richard Leblanc, a professor of governance, law, and ethics at York University, said it is unusual to have that level of crossover between two boards.

The corporate governance concern in such as scenario, he said, is that “it skews behaviour, because you are simultaneously serving two masters.”

But Carol Hansell, a corporate governance expert at law firm Hansell LLP in Toronto, said corporate Canada is small enough that such overlaps are not as uncommon as one might think.

She said the key in such cases is how potential conflicts are handled.

“We would advise that in some situations it’s just better not to sit in two places,” she said.

“They will necessarily know a lot about both situations, and so it will be better for them to not have two masters.”

While the resignations from the boards of Home Capital and HOOPP resolve some concerns, questions remain about how the deal came together. Leblanc, for instance, would like to know whether any other lenders outside the syndicate were approached or considered.

“Normally you shop the opportunity to a number of providers and… you pick the best deal you can get. We don’t know if that was done,” he said.

He also questioned whether the investment in a “distressed” company was in keeping with a pension fund’s risk appetite.

HOOPP issued a statement Thursday confirming it is part of a syndicate of lenders to Home Capital, which said the pension has “a long history of providing these types of investments as appropriate, risk-balanced vehicles to meet … overall return targets.”

The statement added that the investment followed “all the appropriate due diligence.”
While professor Lebanc raises a good point about shopping around for a better deal (I think Home Capital panicked and jumped on the first deal it can secure; its rival, Equitable Group just secured better terms on its $2B line of credit), he certainly doesn't understand the terms of this loan and how it most certainly keeps with the risk appetite at Canada's large, well-governed pensions.

Importantly, HOOPP's senior managers did their job to provide a loan with very favorable terms which mitigate downside risks. This loan was structured in a way to be in the best interests of HOOPP's members.

But Carol Hansell is absolutely right, the president of any major Canadian pension fund shouldn't be sitting on the board of any public company where there is even a smidgen of a perceived conflict of interest. In my opinion, Jim is very honest and most definitely has the best interests of HOOPP's members at heart, but he shouldn't have been allowed to sit on Home Capital's board (a governance lapse which I'm sure will be rectified).

And let's be honest, if Jim wasn't sitting on Home Capital's board, would the company have secured a $2 billion loan from HOOPP and a syndicate of lenders so quickly? I highly doubt it.

Those are my brutally honest thoughts on HOOPP's Home Capital fiasco. As always, feel free to send me your thoughts if you disagree or want to add anything else (my email is LKolivakis@gmail.com).

Below, Healthcare of Ontario Pension Plan chief executive Jim Keohane tells BNN he doesn’t see Home Capital as a risky investment, despite customers having pulled out hundreds of millions worth of deposits in the past 30 days, leaving observers concerned over how the lender will fund new mortgages. If it does not load below, watch this interview here.

Also, if you want to see what a real conflict of interest looks like, watch this clip where Bill Whitaker of 60 Minutes reports on how the Supreme Court of the United States overturned the conviction of former Virginia governor Bob McDonnell, despite Chief Justice John Roberts describing his public corruption case as “tawdry tales”.

This just confirms how institutionalized corruption is supported by the nation's highest court. I openly worry other governors accepting "loans, trips and gifts" from businessmen, including rich hedge fund and private equity managers will see this as open season to continue shady and corrupt practices in their own state. Watch the clip here and draw your own conclusions on the governance at US public pensions.

Update (May 1st, 2017): Alternative lenders are on the defensive as the sector is getting hit amid the Home Capital scandal. Equitable Bank CEO Andrew Moor joins BNN to defend his company, stating "We're not interested in Home Capital's assets." If it does not load below, watch it here.

Update 2 (May 9, 2017): Reuters reports that no. 1 Canadian nonbank lender Home Capital Group Inc (HCG.TO), which is facing accusations of fraud, said on Tuesday a third party intends to buy up to C$1.5 billion ($1.10 billion) worth of its mortgages, sending the shares up as much as 28 percent.


No comments:

Post a Comment