DBRS Revises Rating Review of Home Capital Group Inc. to Under Review with Positive Implications

DBRS Limited (DBRS) has today revised its review of the ratings of Home Capital Group Inc. (HCG or the Group) and Home Trust Company (HTC or the Trust Company), HCG’s primary subsidiary, to Under Review with Positive Implications from Under Review with Negative Implications, following the release of Q2 2017 results.

The rating actions reflect DBRS’s view that the Group has made solid progress in restoring market confidence, including stabilizing funding, albeit at a higher cost. Specifically, HCG has hired an experienced Chief Executive Officer, closed an equity investment from Berkshire Hathaway Inc. (Berkshire), sold assets, made progress on outstanding litigation issues and fully repaid its high-cost backstop credit facility. The Group has also seen modest deposit-balance increases since the Berkshire announcement. HCG has also indicated that its search for a Chief Financial Officer is near completion. These steps, especially the improved liquidity position, have lessened the concerns over the Group’s viability and has given HCG time to strengthen its business model going forward.

Positively, the Group noted that its aggregate liquidity position improved to $3.94 billion on August 1, 2017, from $1.53 billion on June 29, 2017, primarily benefiting from asset sales that resulted in proceeds of over $1.4 billion with more sales pending. DBRS notes that available liquidity is equal to approximately 20% of HCG’s balance sheet as of June 30, 2017. Deposit balances have also grown since the Berkshire investment, although rates are considerably higher than deposits that HCG was able to attract in the past.

Reflective of the serious liquidity event that started in April 2017, HCG incurred significant costs to attract and stabilize funding. Indeed, incremental costs associated with the liquidity event totalled $213.6 million, primarily from high commitment fees and interest rates, but also included $72.9 million of realized losses related to securities sales. Litigation-related costs and various restructuring costs also negatively affected profitability. Overall, the Group reported a sizable Q2 2017 net loss of $111.1 million. After curtailing mortgage originations in the quarter, HCG noted that it expects to gradually ramp up lending again as it grows deposits while passing on at least a portion of its higher funding costs to borrowers.

Despite the large loss, HCG’s Common Equity Tier 1 ratio improved to 17.06% during the quarter, reflecting the aforementioned asset sales and capital from Berkshire. While asset sales have helped to stabilize funding and improve capital, the sales will negatively affect future earnings generation. DBRS notes that other pending asset sales and a potential second tranche of equity from Berkshire in Q3 2017 should bolster capital metrics further.

The review will focus on the Group’s ability to attract funding at more reasonable costs, return to sustainable profitability considering current housing market conditions as well as weather the potentially adverse impact of the recently proposed Guideline B-20. DBRS expects to conclude the review shortly after Q3 2017 earnings are announced and notes that the upgrade could be one or more notches.

RATING DRIVERS
The ratings could be upgraded if HCG is able to attract additional funding at lower costs and demonstrate a path to improving profitability. Moreover, the further build-out of the senior management team would be viewed favourably. Conversely, the ratings could come back under pressure if funding costs remain too high to have a viable business model or if the Group is unable to restore its relationships with brokers and clients.

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 (May 2017) and Rating Canadian Residential Mortgages, Home Equity Lines of Credit and Reverse Mortgages (November 2016), which can be found on dbrs.com under Methodologies.

Lead Analyst: Maria-Gabriella Khoury, Vice President – Global FIG
Rating Committee Chair: William Schwartz, Senior Vice President - Global Credit Policy

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.

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