Mortgage Companies Gain as Bubble Talk Spurned: Corporate Canada

Thursday, May 22nd, 2014

Greg Quinn

Mortgage insurer Genworth MI Canada Inc. (MIC) and lender Home Capital Group Inc. (HCG) are surging as investors wager the country will avoid a housing bubble and the companies pick up business vacated by the government’s housing agency.

Genworth, Canada’s largest private residential mortgage insurer, has advanced 54 percent over the past year while Home Capital, the country’s biggest non-bank mortgage lender, has returned 69 percent. That eclipses the 18 percent gain in the Standard & Poor’s/TSX Composite Commercial Banks Index which includes Toronto-Dominion Bank and Royal Bank of Canada.

The companies are poised to benefit as Canada Mortgage & Housing Corp. scales back taxpayer exposure and the market defies predictions from some economists for a slump after prices jumped 29 percent nationwide in the past five years.

Analysts project Home Capital will rise 12 percent to C$51.05, according to the average of 11 estimates compiled by Bloomberg, while Genworth is expected to gain 7 percent, according to the average of nine estimates. Home Capital fell 1.2 percent to C$45.47 at 10:08 a.m. in Toronto while Genworth was little changed at C$38.15.

“People had put a significant discount on these two housing names over the perception there would be a significant issue in Canadian housing, which is proving not to be the case,” said Asim Imran, equity analyst at Macquarie Capital Markets Canada Ltd. in Toronto, by telephone.

Prices Jump

Home Capital, which focuses on underserved customers such as the self-employed and immigrants who make up 20 percent of the housing market, reported first-quarter adjusted profit of C$1 a share, exceeding (HCG:US) the 98-cent average estimate compiled by Bloomberg. Genworth reported first-quarter earnings of 96 cents a share that exceeded the 89-cent average estimate.

Average home prices rose 7.6 percent in April from a year earlier, the Canadian Real Estate Association said May 15. Prices are up 29 percent in the five years through April, according to CREA. Housing starts also rose faster than economists forecast in April on gains in multiple-unit projects, CMHC said May 8.

“It may be expensive but people seem to be able to afford what they are buying,” Home Capital Chief Executive Gerald Soloway said in a May 15 telephone interview. He reiterated the Toronto-based company is targeting 15 percent profit growth in the next year. “The experts that were saying Canada’s housing market had to follow the U.S. were wrong, just plain wrong.”

Building Slows

The companies’ earnings could grow further after CMHC said last month it would stop insuring mortgage loans on second homes and for people who are self-employed and can’t provide outside verification of their income. It was the latest in a series of steps taken to reduce taxpayer risk and cool the housing market.

CMHC’s shrinking role in the housing market “has presented an opportunity for us to step up, broaden our role,” Genworth CEO Brian Hurley said by telephone May 16. “The soft landing we were looking for has materialized.”

Hurley said there are only “pockets” of concern in the housing market and Oakville, Ontario-based Genworth has scaled back some financing for condominiums, an area policy makers have said is at greatest risk of overbuilding.

“We like how the builders have intentionally slowed down their deliveries,” he said.

Toronto has more condo towers under construction than any other North American city, according to industry researcher Emporis GmbH.

Elevated Leverage

Other observers, such as Fidelity Investments portfolio manager David Wolf, say parts of the housing market are overvalued. The Organization for Economic Cooperation and Development said May 6 Canada should take further steps to stabilize housing, citing a 90 percent price gain since the start of 2000, second only to 97 percent in New Zealand. The International Monetary Fund said April 8 that “elevated household leverage and house prices remain a key vulnerability.”

Home Capital stands to benefit more from faster growth for uninsured mortgages, while Genworth’s growth for insured loans will be slower, Imran at Macquarie said. Canada requires mortgage insurance where the down payment is less than 20 percent of the purchase price.

Home Capital has “brighter” prospects than Canada’s big chartered banks according to Fred Westra, equity analyst at Industrial Alliance Securities. Rising immigration may give the company an advantage over bigger banks in coming years as new Canadians are less likely to qualify for a standard mortgage, he said.

Loan Losses

“Everything is better with Home Capital than the Canadian banks,” he said said by telephone from Montreal. Home Capital has loan “losses that are probably three times lower than the Canadian Banking Association average, their return on equity is 24 percent, which is better than the Canadian banks, they are growing at a faster pace than the Canadian banks.”

Home Capital’s common equity tier 1 capital ratio of 16.8 percent was higher than the average of 12 percent among major banks and the federal banking regulator’s minimum of 7 percent, the company said at its May 14 annual general meeting.

Triggers for a housing crash, such as a rise in unemployment to 12 percent, are unlikely, said Westra. Canada’s jobless rate currently stands at 6.9 percent.

One key policy maker who agrees with the soft landing scenario is Bank of Canada Governor Stephen Poloz, who says he’s tracking consumer debt burdens that are stabilizing after reaching record highs. Household debt rose 4.5 percent in the final quarter of 2013, the slowest pace since 2001, data released in March showed.

“You are going to see a solid performance at both these companies driven by low loss ratios,” Imran said. “I just don’t see a crash happening.”

©2014 Bloomberg L.P.

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