A cooling housing market isn’t ideal for mortgage providers. But as long as there isn’t a big drop in house prices, there shouldn’t be a major problem. Growth in mortgage originations will slow in step with the housing market, but there shouldn’t be significant loan losses.
Loan losses are particularly key for alternative mortgage providers such as Home Capital Group Inc. (HCG) and Equitable Group Inc. (EQ), both based in Toronto, because many of their mortgages are not insured by Canada Mortgage & Housing Corp. That means HCG and EQ have to bear any losses themselves.
But house prices would have to drop substantially before there would be big losses, says Marc Charbin, financial services analyst with Laurentian Bank Securities in Toronto. At HCG, the market price’s drop would have to be more than 26%, the average down payment for HCG’s mortgages.
Jaeme Gloyn, diversified financials analyst in Toronto with Montreal-based National Bank Financial Ltd., agrees, saying that most mortgage providers would have to see house price declines of more than 20% before they would experience large losses.
Although neither Charbin nor Gloyn is expecting big price declines nationwide, there can be problem areas.
Gloyn notes that Alberta house prices could decline by 5%-10%. Still, that market isn’t a major issue for HCG, as its exposure to the province is only about 5% of total loans outstanding, he says.
Exposure to Alberta is more significant at EQ, which has 15% exposure to the province. But, Gloyn points out, a stress test done by that company, assuming a 30% house price decline and unemployment rising to 10.5%, would take just 1.2% off of 2017 earnings per share.
Both HCG and EQ do most of their business in Ontario: 62% for EQ and more than 80% for HCG. That exposes them to the risk of a significant drop in Ontario house prices. However, Gloyn notes, “The Greater Toronto Area, driven by immigration, is still very strong.”
Here’s a look at the two companies in more detail:
– equitable group inc. EQ’s mortgage portfolio is more diversified geographically than HCG’s. EQ also has a higher percentage of insured mortgages, about 45% of total mortgage principal outstanding as of June 30, vs just 22% for HCG. The latter measure means that EQ has relatively less credit risk because insured mortgages carry little, if any risk.
Gloyn is particularly impressed with the increase in EQ’s uninsured mortgages, which were up by 49% in the second quarter (Q2) of 2016 vs Q2 2015. (Growth in this category was only 6% for HCG.) He expects EQ to continue its industry-leading growth and also that EQ will “sustain solid credit quality in spite of relatively higher exposure to Alberta and Saskatchewan.”
Gloyn has an “outperform” on EQ’s shares, with a one-year price target of $74 a share. The 15.6 million outstanding shares closed at $60.08 on Sept. 21.
A recent report from Bank of Nova Scotia of Toronto rates the stock “sector perform,” with a one-year target price of $71 a share because the current share price “looks quite reasonable.”
EQ’s net income in the six months ended June 30, 2016, was $61.4 million vs $63 million in the corresponding period a year earlier. Revenue was $140.8 million vs $125.7 million.
– home capital group inc. HCG was a star for many years, posting average annual earnings growth of almost 30% in 1999-2014. But growth has slowed, largely because HCG had to suspend 45 brokers between September 2014 and April 2015 because of issues regarding verification of income in mortgage applications.
This slowdown caused declining revenue growth and higher costs as the company devoted more resources to the mortgage approval process. In addition, says Gloyn: “Service levels deteriorated materially, both in terms of the time for a decision on an application and the consistency of those decisions, and are still not back to previous levels.”
Gloyn has a “sector perform” on the stock, with a one-year price target of $31 a share. The 65.7 million outstanding shares closed at $28.25 on Sept. 21.
Recent reports from Bank of Nova Scotia and Toronto-based Royal Bank of Canada’s (RBC)capital markets division have a “sector perform” or “hold” on the stock, but with higher targets of $36 and $33 a share, respectively.
Charbin, however, has a “sector outperform” and a $35-a-share price target: “It’s quite cheap for a company with a 16% return on equity, which is in an excess capital position with very high Tier I capital and has a strong brand.”
HCG’s net income in the six months ended June 30, 2016, was $130.5 million vs 144.6 million in the same period a year earlier. Revenue was $294.1 million vs 290.8 million.
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