Entries from April 2017 ↓

Lessons

A year ago a single share in Home Capital traded on Bay Street at $39. Today it was $8 – and this was actually a good day for the failing subprime lender. There are several lessons in this story which this week gripped the mortgage industry, the financial sector, regulators and depositors.

First, if you need another good reason not to buy individual stocks, here she be. Retail investors never actually know what’s going on inside the boardroom, despite all the regulatory requirements about disclosure. Home Capital was an investment-grade entity a few months ago, and this week had to take a $2-billion loan at outrageous interest just to keep the doors open. The stock collapsed almost 80% in a year, and 64% in a single day.

So while this is a loser company with a failed management team that has been shorted to death by people betting against our housing bubble, it still has hundreds of thousands of investors with shares in their RRSPs and TFSAs – where losses cannot even be written off. Lesson: diversify. Own the whole market through an index-based ETF and never think you are smart enough to pick winners. You’re not.

Second, Home Capital runs Home Trust and Home Bank, and has billions of savers’ money in its vaults. Well, actually, it doesn’t have any (or much), since it was all given out in the form of mortgages to people too financially dodgy to qualify for loans at the banks. Most of the $13 billion in GICs is locked in, so depositors cannot get at their money to move it. But the funds in high-interest accounts continue to bleed away – another $300 million yesterday.

Home responded by upping its rate on deposits by a half a percentage point which these days is big money. This move promises to makes its balance sheet a little stinkier than it already is, but the outfit has little choice. All that money being removed needs to be covered. Why did so many people entrust billions and billions to a company now held together with bungee cords? Because it was paying a little more interest than the Big Five on deposits.

Lesson: Know where you’re putting your cash and never be seduced into handing over money because of a pathetic premium on the deposit rate. The more you receive in interest, the more risk you embrace (that’s why they pay more). Yes, we have deposit insurance in this country, but the limits are constrained and the process lengthy. Nobody needs that stress – especially risk-averse, wussy investors who would opt for brain-dead, illiquid GICs in the first place.

Third, the collapse of Home Capital (the carcass is now for sale) and the spray it got all over other subprimers like Equitable Trust (owner of EQ Bank) won’t immediately result in the GTA or YVR housing bubbles being shot from the sky. But it hurts.

This is one more nail in a coffin of inevitability. Ontario’s 16-point plan last week to piddle on the housing fires was one. BC’s election, resulting (possibly) in an NDP government, will be another (God help us). Rising interest rates, falling taxes and protectionism in Trumpland will be another. Nosebleed prices, a 33% one-year appreciation and buyer shock in Toronto yet another. A surge in listings as more people understand the party is ending, a big one. And the implosion of the country’s largest Alt lender the latest nail.

Lesson: This is a dangerous time to buy and a fading chance to sell. In fact, you may already be too late. Bidding wars are winding down, realtor auctions resulting in no bids, asking prices being moderated, buyers backing out and the media turning critical. Of course, most people have yet to clue into the change, and we’ll continue to see lineups for new developments or pre-sale condos plus competition for scarce homes in demand areas. But if you don’t need to purchase, wait. If you really need to sell, pounce. In both cases, be aggressive.

We may forget about Home Cap in a year or two. But we will not avoid the consequences. Might as well learn something.

Conflicted

By now I’m sure all dogs know our primo Alt mortgage lender, purveyor of liar loans and featuring executives being fitted for leg irons – Home Capital – was saved from destruction by a fat loan from a pension fund. Not just any fund. HOOP – the Heathcare of Ontario Pension Plan, representing all the grunts who look after you. The loan is worth $2 billion, secured by mortgages, and speculative enough the interest on it slides between 15% and 22.5%.

This deal is so out of the box for a pension plan, whose solitary and legislated purpose is funding the retirements of its members, that HOOP was moved Thursday afternoon (after the markets closed) to issue a statement admitting what it had done:

TORONTO, April 27, 2017 – 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.

But was this bold bail-out of a subprime lender in flames really in the best interests of thousands of nurses and medical workers? Or was it a favour?

James Keohane is president and CEO of HOOP, and as such carries this mandate: “responsible for the overall leadership and management of the organization, as well as for developing, implementing and overseeing – in consultation with HOOPP’s Board of Trustees – performance measurement programs, long-term strategies and annual work plans to ensure the organization meets the needs of Plan beneficiaries.” As you’d expect.

But Jimmy is also a key director of Home Capital Group, and as such has intimate knowledge of the company’s troubled finances (it was cut to junk status today by rating agency S&P). Union members may wonder about lending $2 billion to a company which lost 65% of its capitalization in a single day.

Mr. Keohane is bound by Home Capital’s guidelines, which mandate: “The Director avoids potential or actual conflicts of interest that are incompatible with services as a director…” And as CEO of the pension plan, he has a personal fiduciary responsibility to the beneficiaries – which means he must (by law) put their interests ahead of his own. Given his role as a Home Capital executive, and his ownership position in the mortgage lender, this must be tough tightrope to walk.

Well, I don’t know JK. He may have honestly believed risking so much of his members’ money on a company blowing up under his own tutelage was smart. Good business. Maybe with a big payoff. But it would have been a nice gesture for him to resign the board seat first and sell his shares. Then the chattering classes would go and worry about something else. (He resigned earlier today.)

Like taxes.

The Trumpian plan to reform the US tax code didn’t receive a lot of ink in Canadian media yesterday. No wonder. We are so embarrassed. While Canadians are fed into the CRA meat grinder and the deplorables on this blog clamour for even higher levies, American taxpayers seem destined to pay less. Lots less. (And they already fork out just a fraction of what high-income beavers do.)

The plan proposes taking the existing seven tax brackets, consolidating them to three and slicing the top tax rate from almost 40% down to 35%. An extra investment tax on people making over $200,000 would be punted along with estate taxes and the alternative minimum tax. No more writing off local/state taxes, and the only deductions allowed would be for home mortgage interest and charitable giving.

Meanwhile, our top tax personal rate is now well over 50%, T2 brought in a special bracket to Hoover people earning $225,000+, the TFSA contribution limit was halved and it’s a safe bet capital gains and small business corporations won’t survive the next budget unbloodied. Effective tax planning, and aggressive avoidance have never been more essential for people who created wealth and want to keep it.

But the biggest deal? That’s corporate tax. Trump’s plan hacks it from 35% to 15%. Add in state taxes, and the average US-based company will pay a 20% rate. That compares with 27% in Canada – where wages are higher, benefits a greater burden, power more costly, and all your employees are stressed out trying to buy $1.5 million houses.

At least we dominate hockey. Oh, wait…