Alt-lenders in 'golden age' as housing market softens

Short sellers stalk Home Capital as housing prices slide.

Over the past two decades, Home Capital Group has quietly become the country’s largest alternative mortgage lender, serving Canadians who can’t get mortgages with the big banks. The company has been remarkably kind to investors, too, with a 25% return on equity annually for the past nine years. But for all its success, some are betting Home Capital will fall in a softening real estate market.

“If you asked me the investment I’m most excited about, it’s my short position in Home Capital,” says David LePoidevin, founder of the LePoidevin Group in Vancouver. The investment adviser, who manages a portfolio worth $520 million, has been building a short position since 2010. He’s not alone, either. Analysts say U.S. hedge funds, expecting the Canadian housing market to crash, at times short the stock. The percentage of Home Capital shares sold short reached a high of nearly 10% this summer.

Roughly half the company’s $15.3 billion in residential mortgages have been issued to the so-called Alt-A market, a grey area between prime and sub-prime lending. “Their target market is people who have been turned away by a major bank,” LePoidevin says, “and the banks are already fairly lax in Canada about who qualifies and who doesn’t for a mortgage.” That clientele is vulnerable in the event of a severe correction, which LePoidevin is banking on. Deliquencies are low at Home Capital—only 0.31% of loans were non-performing at the end of the second quarter—but he expects that to rise, especially as the availability of credit tightens. Home Capital will also have a hard time selling foreclosed properties if prices are falling.

Company president Martin Reid argues such negativity is misplaced. Home Capital’s clients, most of whom are in Ontario, are not the “no income, no job” borrowers serviced by U.S. sub-prime lenders. Instead, the lender targets self-employed individuals and immigrants who, while employed, may not have a credit history. Borrowers with damaged credit account for between 10% and 30% of clients, according to Reid, but they tend not to be serial delinquents.

What reassures analysts is the fact its borrowers are generally required to put down at least 20%. Homeowners with equity in their properties will do everything possible to make mortgage payments to avoid foreclosure—perhaps more than a prime borrower with just 5% down. Upon initiating coverage this year, Fred Westra of Industrial Alliance Securities wrote, “alternative lenders will experience a golden age” as tighter lending standards for banks push more customers their way.

As for LePoidevin, he’s increasing his short position as the housing market cools. “I have a hard time believing I’m wrong now,” he says. “The slowdown is happening.”