DBRS Confirms Home Trust Company’s Long-Term Rating of BBB (high), and Short-Term Rating R-2 (high), Stable Trends

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

DBRS’s rating confirmation reflects HCG’s position as a well-established niche player with a meaningful presence in those product lines where it competes in the Canadian residential mortgage space. As of Q3 2015, HCG had total loans under administration of $23.4 billion, mostly in residential mortgages. Besides its franchise, the Group also derives its strength from its risk profile, including the quality of the assets against which it lends, its capital position that provides a cushion against losses in adverse scenarios, and its earnings ability relative to likely loan loss provisions and general underwriting practices.

The Stable trends take into consideration the strength of the Group’s fundamentals and its ability to cope with the current weakening economic environment. At the same time, DBRS remains cautious about the Canadian real estate market, house prices, loan quality and consumer indebtedness. The weakening of the Canadian economic environment, with its still low energy prices, has elevated these concerns. With significant exposure to the Canadian residential mortgage market, HCG’s asset quality may weaken more than anticipated should there be a significant downturn in the market, which would in turn have an impact on provisioning levels and profitability.

HCG has traditionally focused on its assessment of the value of the assets against which it underwrites mortgages. DBRS recognizes that this likely contributed to some shortfalls in the verification of borrower income documentation that emerged this past year. As a result, the Trust Company suspended relationships with a group of approximately 45 brokers identified as being associated with falsified mortgage applications. HCG has since implemented a more extensive income document checking process. So far, HCG is reporting that it does not expect to experience notable losses from this group of mortgages or that it will need to increase credit provisions.

DBRS considers HCG’s earnings power to be strong. Its low cost structure has ensured that more of its revenues, driven primarily by net interest income, flowed to the bottom line than at most banks. The Group achieves strong efficiency ratios that are typically around 30%, which in part reflects its business mix. Return on equity (ROE) levels are slightly down from the historically typical mid-20s, as earnings remained flat in 9M 2015. Loan loss provisions are low and easily covered by income before provisions and taxes in the current economic environment. The Group’s continued relatively low dividend payout levels are supporting its strong risk-based capital ratios.

In DBRS’s view, HCG has taken a prudent approach to liquidity and funding. It typically match-funds its term assets with liabilities of a similar tenor. However, its funding relies primarily on just two sources: brokered deposits and securitization. HTC acquired CFF Bank at the end of 2015 to improve its funding mix, increase originations and grow its business.

HCG is considered to be well capitalized with a Q3 2015 Common Equity Tier 1 (CET1) capital ratio of 18.06%, well above regulatory minimums. DBRS’s analysis using its Canadian Residential Mortgage-Backed Securities (RMBS) model showed that this level of capital indicates a sizable buffer against loan losses in an adverse scenario, which supports the rating level. HCG’s ability to internally generate capital has been strong, driven by its consistently high ROE and a low dividend payout.

Improvements in HCG’s overall credit strength, including enhancements in the quality of the loan portfolio and increased diversification of funding, could put positive pressure on the ratings. On the other hand, defaults in the suspended broker portfolio, evidence of significant loan losses, increased competition or a weakening in the regulatory environment would be negative for the rating assessment.

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.

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

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (December 2015) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (December 2015). Additionally, the methodology Rating Canadian Residential Mortgages, Home Equity Lines of Credit and Reverse Mortgages (November 2015) was applied via the use of DBRS’s RMBS model as a way of effectively stress testing the uninsured residential mortgage portfolio. These documents can be found on DBRS’s website at www.dbrs.com.