Home Capital mortgage fraud probe uncovers more suspended broker loans

Alternative mortgage lender Home Capital Group saw the value of its new mortgage originations decline by 15 per cent last quarter and said the cost of loans tied to an exiled group of brokers is almost twice as much as first reported.

The company said the value of its uninsured single-family residential originations was $1.51 billion in its most recent quarter, which ended Sept. 30. That's up from the summer's level, but down by 15 per cent from where it was in the same period a year ago.

The company also signed $416 million worth of insured loans, a figure that declined 20 per cent from the same period a year ago.

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Home Capital was thrust into the spotlight over the summer when it revealed it had cut ties with several dozen mortgage brokers for falsifying income details about borrowers.

At the time, Home Capital said those brokers had brought in about $960 million worth of loans in 2014, about five per cent of the company's total loan book.

On Thursday, the company revealedthat at the end of June, the value of loans that originated from those brokers was actually more than twice that $1.93 billion since they started working with the company. But by the end of the most recent quarter, that figure had declined to $1.72 billion and the company"expects this balance to decline as customers pay down loans."

The company said its investigation into the issue isabout 25 per cent done, and expects it to be finished sometime in 2016. It is currentlyin the process of reviewing what it calls "income documentation" for all of theborrowers thought to be in the problematic groupand"taking corrective action accordingly."

Home Capital also said:"Of the accounts reviewed, the company has determined that over 90 per centof the mortgages reviewed to date could be eligible for renewal."

Earnings fall

On a conference call to discuss the results with investors and media on Thursday,CEOGerald M. Soloway saidall the mortgages in the group originated by the exiled brokers are performing as well, or better, as the company's other loans.

Default rates are low, and the company is prepared to deal with any issues that may arise, and he stressed that the issues identified are with documentation not creditworthiness.

Home Capital has been unable to confirm documentation with about seven per cent of the mortgage holders examined so far."We willhave a circle around those loanswhere we could not get full documentation,"Solowaysaid."So far,they are all payingand we will deal with this group on renewal time."

He also stressed that the group of brokers who have since been cast out represent a tiny percentage of the total that the company deals with.

Despiteletting go 45 brokers in the probe, the company has started relationships with 600 new ones since the start of the year, and currently has4,800 across the country who have done at least one deal with the company this year, Soloway said on the call.

Not everyone in the investment community is convinced that everything is fine, however. On the call, the CEO was peppered with questions from analysts about why, exactly, it's taking so long to sift through details about income documentation for what it insists is a small group of mortgage holders.

"Management claims that a whistleblowernotified the company of irregularities in its underwriting and loan approval process as far back as [the fourth quarter of 2014]," Bradley Safalow at independent research firm PAA Research, said in a note to clients after the quarterly numbers came out."Twelve months later and the company is just now getting through 25 per cent of its review process? How hard is it to verify income on a mortgage? Or determine if someone works for a company?"

Earnings slip, dividend maintained

"In some respects, it seems like HCG management wants to avoid finding out about the true extent of the problem in the hope that these loans will simply go away through normal renewal and refinancing activity," Safalow said.

Safalow has a "sell/short" rating on the stock, and gives it a target price of $20 a share more than a third below its current level.

Another analyst, Marc Charbin at Laurentian Bank, says he thinks the company's underlying numbers are fine once the noise of the documentation problems goes away. "We are increasingly of the belief that as the company refines its new processes and allocates resources away from dealing with problem files to generating new business that investors will return to assessing growth prospects, as opposed to avoiding potential risks."

Beyond the documentation issue, the company's earningsfell 1.8 per cent to $72.4 million, or $1.03 a share. The company also maintained its dividend at 22 cents per share.

Home Capital shares opened down about four per cent on the TSX on Thursday before the call with management began, when they started rallying. Towardthe end of the trading day, they were about where they were before earnings came out, changing hands at around $33 per share.

This time last year, they were trading north of $55 per share.