DBRS Downgrades Home Capital Group Inc. to BB; Places All Ratings Under Review – Negative

DBRS Limited (DBRS) has today downgraded Home Capital Group’s (HCG or the Group) Senior Debt rating to BB from BBB (low) and its Short-Term Instruments rating to R-4 from R-2 (low). Additionally, DBRS has downgraded the ratings of Home Trust Company (HTC or the Trust Company), HCG’s primary operating subsidiary, including the Issuer Rating as well as the Deposit and Senior Debt rating to BB (high) from BBB. DBRS has also downgraded the Trust Company’s Short-Term Instruments rating to R-4 from R-2 (middle). Concurrently, DBRS has placed all ratings Under Review with Negative Implications. The Support Assessment for HTC remains SA3, which implies no expected support for the Trust Company; subsequently, DBRS has lowered HTC’s Intrinsic Assessment to BB (high) from BBB.

The rating actions reflect DBRS’s concern over the heightened pressure on HTC’s funding and liquidity profile as well as the potential impact of this pressure on the Trust Company’s earnings generation and franchise. HTC has faced accelerated withdrawals of on-demand High Interest Savings Account (HISA) deposits since the announcement of various senior management changes and the Ontario Securities Commission’s (OSC) filing of a Statement of Allegations against three former members of senior management. Specifically, HISA balances, which stood at $2.0 billion at December 31, 2016, have fallen to $1.4 billion as of April 24, 2017. At the same time, HTC’s Guaranteed Investment Certificate deposits, which mostly comprise confidence-sensitive broker-sourced deposits, have decreased to $13.0 billion as of April 24, 2017, from $13.4 billion on December 31, 2016, with the vast majority of these outflows occurring in recent weeks.

To address its deteriorating liquidity position, the Group announced this morning that it has reached an agreement in principle with a major institutional investor for a credit line of up to $2.0 billion, for which it expects a firm commitment later today. This high-cost 364-day facility would be secured against a portfolio of HTC mortgages. In exchange for the immediate liquidity, HTC would be required to pay a $100 million non-refundable commitment fee and make an initial withdrawal of $1.0 billion. The interest rate on outstanding balances would be 10.0% in addition to a standby fee on undrawn funds of 2.5%. In DBRS’s opinion, the resulting interest and fee payments totalling $225 million at best, or $300 million if fully drawn, over the next year on the facility would put material pressure on earnings. Indeed, even in the best-case scenario of drawing the minimum $1.0 billion on the facility, these costs would represent 67% of the Group’s FY2016 income before taxes of $335 million. Moreover, other funding costs are likely to trend higher while originations are likely to decline, given the recent provincial government’s proposed measures to temper the overheated Ontario housing market, placing further pressure on earnings. This pressure comes at a time of significant senior management turnover at the Group, including an interim Chief Executive Officer and an upcoming change in the Chief Financial Officer position, as well as the overhang of the OSC investigation, all of which make it much more difficult for the Group to focus on stabilizing, then improving upon, its financial position. DBRS notes that the initial OSC hearing is scheduled for May 4, 2017, and has the potential to draw further negative attention to HCG.

Partially mitigating these concerns is the Group’s substantial capital cushion in excess of the regulatory minimum, which stood at approximately $825 million at year-end, when the Common Tier 1 ratio stood at 16.55%, as well as the still-sound asset performance of the mortgage portfolio.

The review will focus on HCG’s ability to stabilize funding at a reasonable cost and make key senior management hires while assessing the extent of the adverse impact that these developments will have on the Group’s franchise strength, including the ability to maintain broker relationships for both mortgage originations and funding.

RATING DRIVERS
Ratings could be lowered if HCG is unable to stabilize its deposit outflows or make key senior hires in a timely fashion and if the new executive team is unable to put forward a credible strategic plan to improve the Group’s funding and performance.

Conversely, the ratings could revert to Stable if HCG is able to stabilize its funding profile while demonstrating a clear path to sustainable profitability.

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 principal methodologies are Global Methodology for Rating Banks and Banking Organisations (July 2016); Rating Canadian Residential Mortgages, Home Equity Lines of Credit and Reverse Mortgages (November 2016); and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2017), which can be found on dbrs.com under Methodologies.

Lead Analyst: Maria-Gabriella Khoury, Vice President – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of North America FIG

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.