Home Capital’s struggles just part of a more complex problem

Home Capital’s present difficulties might simply be a consequence of the apprehensions surrounding the current business model for Canadian subprime lending, according to a veteran analyst.

Writing for CBC News, markets observer Don Pittis said that the lender’s troubles could have been better timed, in the wake of various federal and provincial-level moves to moderate the real estate market.

“Anyone worrying about whether a soaring market is a bubble waiting to pop must be on the constant lookout for the trigger that could bring the market down. That’s because, historically, markets can continue to climb while containing the seeds of their own destruction,” Pittis wrote.

“Many of us in the media have been warning of an overheated Canadian property market for so long that homeowners, potential buyers and companies profiting from real estate have every reason to be skeptical,” he added. “In the case of Home Capital, the OSC announcement in April that it was going to proceed against the company may have been the trigger…”

However, Pittis emphasized that several other factors were also responsible for stoking the flames of the crisis, underscoring the fundamental complexity of the issues—and the solutions required.

“One was that [Home Capital] raised its mortgage funding from depositors through its banking division. The other is the curse of all lenders suffering from a run: fractional-reserve lending,” the analyst said. “As Home Capital shares began to slide, it was not just shareholders who began to unload. Depositors began to pull their money out.”

“Underlying Home Capital's decline is its position at the bottom end of the mortgage market,” Pittis said. “Canadians are notoriously good at paying off their mortgages. However, by definition subprime lenders, who give out mortgages to people the big banks have rejected, would be first to suffer in a property downturn.”

Fortunately, not all is lost for the lender, as the possibility of a major real estate crash remains unlikely at the moment.

“If the Canadian property market continues to rise, the portfolio of mortgages held by Home Capital is as sound as it was two months ago,” Pittis stated, noting that the company can begin taking the road to recovery if it “can stop the hemorrhaging of its capital.”

“But if the company continues to weaken and fail, leaving its borrowers without an alternative source of money when their mortgages come due, Home Capital could itself become the trigger of larger real estate decline.”

Related stories:
Commentary: Securing oneself against real estate ‘contagion’
Home Capital crisis might precipitate mortgage rates hikes - observers

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