DBRS Confirms Ratings of Home Trust Company at BBB (high) and R-2 (high)

DBRS Limited (DBRS) has today confirmed all ratings for Home Trust Company (HTC or the Trust Company), including the Issuer Rating of BBB (high), Deposits and Senior Debt rating of BBB (high), and Short-Term Instruments rating of R-2 (high). HTC is the primary operating subsidiary of Home Capital Group Inc. (Home Capital or the Group), whose BBB Deposits and Senior Debt rating and R-2 (middle) Short-Term Instruments rating are structurally subordinate to the Trust Company and whose ratings have also been confirmed. All trends are Stable.

Primarily a residential mortgage lender, Home Capital operates in a business that has garnered a lot of attention lately as the Canadian government and regulators have made changes designed to reduce consumer debt levels. In spite of these changes and the continuing potential for a modest house price correction, DBRS views Home Capital as a good investment-grade credit on the strength of its asset quality, risk-based capital levels, earnings ability relative to likely loan loss provisions, and general underwriting practices. Home Capital uses a more asset-based and ‘hands-on’ approach than the larger banks in order to compensate for the quality of the information available for the Group’s typical borrowers. Home Capital’s customers tend to include individuals with limited credit history, past credit issues, the self-employed and new immigrants who may lack a credit history in Canada.

The quality of the loan portfolio is strong. To assess the true quality of the uninsured portion of Home Capital’s mortgage portfolio, the DBRS rating assessment includes analyzing the portfolio using DBRS’s Canadian Residential Mortgage-Backed Securities (RMBS) model. Despite incorporating a number conservative assumptions, the model concludes that HTC is very capable of surviving a greater than 30% overall decline in the Canadian housing market. Comparing the model results year-over-year, DBRS also observed that the quality of the uninsured portfolio has improved, with better loan-to-value ratios and average borrower scores.

Although its earnings are skewed almost entirely to net interest income revenue, Home Capital has maintained strong earnings over many years, supported by low expenses and great efficiency ratios, typically around 30%. Recent return on equity levels around 26% have been typical, the earnings far exceed provisions for loan losses, and the low dividend payout levels have contributed to the strong risk-based capital ratio levels. The Tier 1 capital of 17% is indicative of the sizeable buffer against loan losses observed during the RMBS model analysis which supports the rating. On the other hand, HTC is constrained by leverage, as captured by the Office for the Superintendent of Financial Institutions (OSFI) assets-to-capital multiple.

The assets-to-capital multiple constraint has affected HTC’s business decisions more than usual this past year. The Trust Company slowed insured mortgage production dramatically in favour of uninsured mortgages, which earn a wider margin. Although this shift may produce a return more acceptable to management, it does increase the proportion of lower-quality assets for HTC and DBRS will continue to monitor the quality of the overall portfolio closely.

Home Capital appears poised to continue its strong pace of growth with a strategy focused on growing uninsured residential mortgages and some other lending opportunities, but these come with risks that must be managed carefully so as to not become negative rating factors in the future. Most significantly, changes to mortgage lending rules (mainly from OSFI’s B-20 Guideline) have increased the number of lending opportunities for HTC as some individuals who previously qualified for mortgages at the larger banks no longer meet the banks’ underwriting standards. So far, the flow of these new customers has actually increased the average quality of HTC’s borrower profile, but HTC must remain vigilant to ensure that this growth does not lead to a reduction in its strong underwriting standards.

With the anticipated growth in lending, DBRS will also be keenly watching the funding mix, which we view as excessively dependent on brokered deposits and securitizations, although this dependence is mitigated by disciplined liquidity and matched funding.

Notes:
All figures are in Canadian Dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Global Methodology for Rating Banks and Banking Organisations and DBRS Criteria: Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.