Canadian Bank Run Contagion Begins?

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Yves here. As we show in today’s Links, beleaguered Home Capital Group disclosed who its lender was (the Healthcare of Ontario Pension Plan), and that it has drawn down half of its C$2 billion credit line.

By David Llewellyn-Smith, founding publisher and former editor-in-chief of The Diplomat magazine, now the Asia Pacific’s leading geo-politics website. Originally published at MacroBusiness

Via Bloomberg:

Home Capital Group Inc. extended declines after the Canadian mortgage lender reported additional deposit withdrawals, prompting one of its biggest rivals to seek a C$2 billion ($1.5 billion) credit line to stem any contagion across the country’s financial markets.

Home Capital fell 13 percent to C$6.96 in Toronto, bringing its two-week drop to about 69 percent, on concern that redemptions of guaranteed investment certificates by nervous investors would worsen a cash crunch. High-interest deposits have declined about C$1.6 billion, or 80 percent, over the past month to C$391 million, the companysaid Monday.

“They could be at risk,” said Jaeme Gloyn, an analyst at National Bank Financial Inc. “If investors are pulling their high-interest savings accounts, it’s natural to think that other clients would also be looking to pull their GIC investments.”

The selloff in Home Capital’s stock and bonds, sparked by allegations that it misled investors about its mortgage book, are raising concern that its funding woes may spread to other mortgage lenders. That could derail a red-hot housing market that’s been a key driver of growth for Canada’s economy, accounting for as much as a fifth of output.

Equitable Group Inc., another alternative mortgage lender, said Monday it took out a credit line with a group of Canadian banks after it started seeing “an elevated but manageable” decrease in deposit balances. Customers withdrew an average C$75 million a day between Wednesday and Friday. The withdrawals represented 2.4 percent of the total deposit base. Liquid assets remained at roughly C$1 billion after the outflows.

And from Greater Fool comes texture:

In a moment: are the banks safe?

Let’s set the scene with comments from two blog dogs sitting on opposite sides of the real estate maelstrom. First a poster we’ll respectfully call Dick:

“People, don’t listen to Turnster, he knows nothing about nothing. If you bought into RE 1 year ago, 2, 5, 10, 15, 20 you are golden no matter what. Open your eyes and see for yourselves – RE in Canada will always be of value and will never go down in price. NEVER! There ain’t no bubble here. RE prices simply have caught up with the levels where they should have been in the first place. TO is a major cultural and economic city. I bought last years and it’s gone way up! And always will. And everyone will want to live here. The demand for RE will never dry up. NEVER!”

And here’s a further update from Derek, the dude who blissed out last month when his house went in a bidding war for lots more than he expected: $2.25 million. Then the buyer got cold feet while the other bidders fled. Lawyers are fighting. Derek’s in a funk.

“Well the shit show continues. Buyers did not even respond to our lawyer. We had hoped maybe they would come to their senses but have waited long enough. I just can’t believe peoples mentality. Stick your head in the sand and hope it goes away. So it looks like we are relisting on Monday.

“Really nervous that the market has changed and we will be at a terrible disadvantage now. Dealing with all this and maybe having to sue them is really not the way we had planned on having this happen. Most people I talk seem to feel that I will win if this is the outcome but obviously we are nervous.”

And finally, another dog who just sold for far less than anticipated after an attempt to create a bidding war failed. No offers – even for a detached in prime 416.

“At the beginning of April in this area there was a boat load of sales, before Ontario dropped the hammer.  Since then, just four sales.  Listings have tripled.  Bidding wars being held, but no offers.  Condos listings exploding. Now I just got to find a desperate owner willing to take a haircut on rent.”

Yeah, everyone sees reality through their own lens of experience. The guy who bought recently wants nothing more than validation for having made a sacrifice – which is exactly what it takes to buy into a bubble market. So he pumps, gloats and pumps harder. The person who wants to sell and can’t, sees nothing but disaster looming. The guy who swallowed a lump pf pride and took less, rationalizes the action. It’s impossible to know if the market switch has flipped from ‘Insane’ to ‘Scared,’ but something is afoot.

Days ago the savvy investment wonks at Mawer money managers sold almost three million shares in Home Capital Group, squeaking out the door before it shut behind them. The loss would be staggering, and now the company’s chief investment officer, Jim Hall, is saying some serious things about what the collapse of Home Cap might suggest about the whole mortgage financial business and even (gasp) the Big Banks.

Could the looming death of Canada’s biggest non-bank lender cause a run on deposits at other institutions as depositors start to understand their money went to finance a housing market that could blow up?

“The probability has gone from infinitesimal to possible — unlikely, but possible.” He told the Financial Post. “If depositors or bondholders start to lose faith in their banks, well then that becomes systemic.”

Yikes. Spooky words from a guy who manages $40 billion in assets. And while Home Cap’ mortgages represent just 1% of the entire Canadian home loan business, even little wounds are serious when you’re dealing with a system built on confidence. People blindly put their savings into the GICs and high-interest accounts of outfits like EQ Bank and Home Trust because they got a little more interest and were too trusting to ask when the cash went. (Most of it was loaned out to home-buyers who required high-ratio mortgages and didn’t qualify at the bank.) Now many depositors are desperate to get their cash back – and Home had to borrow $2 billion at usurious rates from an insider to stay alive. As a result, its stock plunged and the corporate carcass is now for sale.

See how it works? Not pretty. And fast.

There’s little doubt our big banks are secure, despite their jaw-dropping exposure to residential real estate. (If you want to worry, fret about the credit unions.) But the residential real estate market is just as susceptible to sharp U-turns in sentiment as GIC-holders in operations like Home or EQ.

On Friday US ratings agency Fitch hoisted a red flag over the GTA’s runaway, but conflicted, market. Ontario’s recent 16-point plan will bite, it says, and it could all start with those universal rent controls – since that market (as we’ve been telling you) has become dominated by speckers.

“The proposed rent controls could dampen price growth in the condo market if the rent investors can charge tenants is limited. Investors who are highly leveraged may be forced to sell, which could begin downward momentum that leads speculators to follow suit. Further, if all measures are passed, municipalities will have the power to introduce a tax on vacant units to encourage sales or rentals of unoccupied units, which may discourage speculators from holding onto vacant properties.”

Well, make up your own mind about what comes next. Dick has.

And from John Hempton comes some damn good advice:

Home Capital Group is an aggressive Canadian home lender that has hit a very rough patch. If you want a history Twitter will do it well. They have been fighting with Marc Cohodes (a very well known short seller) and you will find a timeline of the unfolding disaster by following Marc’s tweets. [Disclosure: I have known Marc for 17 years and we are friendly.]

The crisis came this week when Home Capital Group entered into an emergency loan. The press release is here – but the salient points are repeated below:

TORONTO – April 27, 2017 – Home Capital Group Inc. (“The Company” TSX: HCG) today announced that its subsidiary, Home Trust, has secured a firm commitment for a $2 billion credit line from a major Canadian institutional investor. 

The Company also announced it has retained RBC Capital Markets and BMO Capital Markets to advise on further financing and strategic options. 

The $2 billion loan facility is secured against a portfolio of mortgages originated by
Home Trust. 

Home Trust has agreed to paying a non-refundable commitment fee of $100 million and will make an initial draw of $1 billion. The interest rate on outstanding balances is 10 per cent, and the standby fee on undrawn funds is 2.5 per cent. The facility matures in 364 days, at the option of Home Trust. 

The facility, combined with Home Trust’s current available liquidity, provides the Company with access to approximately $3.5 billion in total funding, exceeding the amount of outstanding High Interest Savings Account (HISA) balances. 

Home Trust had liquid assets of $1.3 billion as at April 25, plus an additional portfolio of
available for sale securities totalling approximately $200 million. 

Access to these funds is intended to mitigate the impact of a decline in Home Trust’s HISA deposit balances that has occurred over the past four weeks and that has accelerated since April 20. The Company will work closely with the lender to have the funds available as soon as possible.

This on the face of it is an extraordinary loan. It is secured by giving the collateral and costs something between 15 and 22.5 percent depending on how much is borrowed.

Its also extraordinary because of what it does not mention. It does not mention who the lender is and it does not delineate what the precise capital is.

But we know that this is being used to pay High Interest Savings Balances. We know there is a run on the bank here here and the run is several hundred million dollars per day.

This is desperation financing. They are securing mortgages (average interest rate below 5 percent) to borrow funds that cost 15 percent or more. The negative carry is huge. A financial institution cannot stay in business under these terms.

The stock reacted – dropping 60 percent in a day. The Canadian exchange busted some trades about $8.20 (because it thought that they were done in error). Mine were amongst the busted ones. I was perfectly happy to sell at that price however in their wisdom the exchange thought that mine was a fat-finger trade. [Disclosure – transaction to sell 30,000 shares at 8.19 was reversed.]

But it is extraordinary because it gives the following details.

a). The loans are secured by 200 percent of their value in mortgages (which makes the investment almost riskless – and Mr Keohane goes to some lengths to describe how low the risk is), and

b). Me Keohane says the deal is more akin to a “DIP deal”. DIP stands for debtor in possession and he is thus saying the deal is bankruptcy finance.

This is an extraordinary position for Mr Keohane to take. He was an insider to both institutions (a true conflict of interest).

What he is saying is that he isn’t taking any risk because he has taken all the good collateral and he expects Home Capital go go bankrupt.

And note that he will make 15 to 22.5 percent return (more if the loan is repaid early in a liquidation) whilst taking no risk.

I have two words to say to this: fraudulent conveyance. In a rushed deal (one that truly surprised the market) done with undisclosed insiders up to four billion of the collateral and maybe three hundred million dollars of book value has been spirited away. And at basically no risk the recipient of all this largess.

Wow that was audacious.  More audacious than just about anything I have ever seen on Wall Street.

Jim Keohane seems to recognise what he has said because almost immediately he says that he doesn’t know what the acronym DIP stands for.

That surprised me: Mr Keohane uses the phrase DIP Financing precisely and accurately and in context and then says he doesn’t know what it means. You should note that Mr Keohane is a very sophisticated fixed income player. (If you want a guide to how sophisticated read this…)

The position of the Canadian Government

The Canadian Regulator is put in an extreme bind. Up to $300 million of value has been spirited away from a highly distressed institution.

The regulator however has guaranteed a very large amount of funding of Home Capital (guaranteed deposits). They should be alarmed at up to $4 billion in collateral being spirited away to HOOP. This effectively subordinates the insured depositors and in the event of Home Capital’s failure will cost the taxpayer several hundred million dollars.

This is not an idle concern. The funding itself indicates that it is very likely Home Capital will collapse. And a former director described this as akin to DIP Financing.

If I were the regulator

If I were the regulator I would be doing my duty here. My duty here is to protect the taxpayer.

Very rapidly Home Capital needs to find a buyer to assume the government insured obligations. It does not matter if this happens at 20c per share. Indeed from a regulatory perspective it is better if it happens at a low share price because it gets rid of claims of bailouts inducing moral hazard.

If Home Capital cannot find a buyer then it should be liquidated. Immediately. And the transaction with HOOP should be reversed under standard bankruptcy rules for reversing fraudulent conveyance. There is no reason that taxpayers should accept subordination to a loan yielding 15-20 percent.

Indeed regulators have a duty to stop that sort of thing.


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  1. Colonel Smithers

    Is this why after playing hard to get, often at the west Oxfordshire estate (Cornbury) owned by his brother in law (Lord Rotherwick, an heir to the Cayzer shipping empire) and near David Cameron’s country house (Dean, all known as the Chipping Norton Set), Mark Carney hot footed it to Blighty and earns twice what Mervyn King earnt and tax free, which makes it almost thrice? Mrs Carney, whose sister is married to Lord Rotherwick, said that Blighty is so much more expensive than Canada, which makes one wonder why Carney does not think inflation is a problem. I suppose the UK’s high cost of living isn’t a concern when the long suffering British taxpayer is paying for his family’s every whim in Hampstead.

    1. PlutoniumKun

      I wonder what his back-up plan is for when the huge private debt load in the UK becomes unsustainable? I wonder if he’s taking mandarin lessons.

      1. Arizona Slim

        Mandarin lessons? Wait a minute.

        Didn’t China’s recently imposed currency controls put the ice on Vancouver’s red-hot real estate market?

        1. cnchal

          No. BC put a 15% foreign buyer’s tax on residential real estate, which shifted the Chinese elite preferred loot stashing and money laundering exercise to Toronto.

          The Ontario government has now imposed a similar tax on foreign buyers, so I expect the elite Chinese looters to shift their money laundering operation to somewhere else, which instantaneously creates a vacuum below.

          There is no rational reason, other than external money coming into the housing market, for average house prices in Toronto which were nearly a million bucks a year ago to climb an additional 30%.

        2. PlutoniumKun

          So far, China’s currency controls have reduced significantly, but nowhere near eliminated, the flows of cash to foreign property markets.

          This actually suggests another issue that could lead to problems for Canada. I believe that quite a few Chinese property purchases in Canada are made with huge local mortgages. This is a common money laundering method whereby the mortgage is paid down in small chunks over a few years in order to avoid moving too much money at one go. This can only happen with the co-operation of the bank. There are two issues that come to mind here – one that maybe there is more beneath the surface of the Canadian banking system that we know about – the other that many of these mortgages could be left high and dry if there was an even more severe Chinese crackdown, with all sorts of implications for the banks.

  2. frosty zoom

    this is very charming, especially coming as canadian taxpayers file on april 30th.

    why do i feel like i just bought mr. keohane a nice villa in the virgin islands?

  3. PlutoniumKun

    There’s little doubt our big banks are secure, despite their jaw-dropping exposure to residential real estate.

    Is this based on hard figures? I seem to remember the same thing been said by normally pretty savvy investors about Irish banks up to 2007, and about the better capitalised Spanish banks for at least a couple of years after that. Long property booms have a habit of encouraging short cuts within even well run banks which only become obvious when the tide runs out.

    1. Colonel Smithers

      Thank you, PK.

      As someone who worked on capital adequacy from the spring of 2008 to the spring of 2014, including with David Llewellyn, I agree with you.

      I have been told by three Canadian former (OSFI) regulators and in separate conversations, from 2010 – 4, about Carnage and former finance minister Ralph Goodale visiting OSFI boss Julie Dixon in the mid-noughties to lobby for a relaxation of capital requirements and allow for greater exposure to the US housing market. Fortunately for Canada, Dixon refused, but had to cite OSFI’s statutory independence. Carnage takes the credit for steering Canada through the crisis, but the credit should rightly go to Dixon, who was later hired by the ECB. Behind every good man…

      1. Moneta

        CMHC (government guarantees) was used to keep real estate going.

        CMHC was recently put under OSFI (banks) supervision…. and we know that conservatives want to privatize CMHC.

        My gut tells me that if real estate tanks and CMHC takes losses paid by the tax payers, then many players will fight to buy it on the cheap… and because of this transfer to OSFI, it looks like the banks would be the first contenders.

        Then the banks would be the mortgage holders and landlords for the foreclosed…

        Time will tell.

        1. Moneta

          And from what I understand, CMHC does not pay out on a defaulting mortgage unless it is convinced the bank has done whatever it takes to have the homeowner make the mortgage payments.

          It’s easy to see the implications if the banks end up owning CMHC.

    2. Quanka

      The statement seems to contradict itself. “Secure” and “Jaw-dropping” don’t usually go in the same sentence like that.

  4. Jim Haygood

    Home Capital has lost over 70% of its high interest savings deposits. But those aren’t its major source of funding:

    The company has C$12.8 billion in Guaranteed Investment Certificate deposits, or GICS. As these 30- and 60-day deposits come due in the coming weeks, depleting HCG’s already tapped out liquidity, and forcing even more emergency loans. Without a deposit base, Home Capital can’t fund new mortgages.

    Typically GICS represent borrowing from insurance companies and other non-bank financial sector entities.

    Aren’t these GICS lenders going to refuse to roll over their loans to Home Capital Group? One would think so. But this being insular, old boy network Canada, regulators may lean on the GICS lenders to keep a stiff upper lip and take one for the home side.

    1. Jim Haygood

      Speaking of regulators, let us savour the words of Canadian finance minister Bill Morneau:

      “I was pleased to see Home Capital’s funding issues resolved by market participants,’’ Morneau was quoted as saying. “What I’ve seen over the last few days is proof the system is working as it should, where institutions facing challenges find market-based solutions.”

      “Market based solutions” — AH HA HA HA

      Translation: “I was pleased to see that private sector victims entities have helped kick this awkward can, postponing my imminent resignation for another day.”

      1. Wisdom Seeker

        “where institutions facing challenges find market-based solutions”

        Better translation: “where my cronies asset-strip this train-wreck while legally sticking shareholders and other prior creditors with steep losses”.

        1. Jim Haygood

          Hey, a problem has arisen. Let’s man up woman up person up:

          OTTAWA – March 23, 2017 – The Government of Canada is currently seeking a Chairperson and Directors to serve on the Board of Directors of the Canada Deposit Insurance Corporation (CDIC).

          Read more about the Chairperson opportunity
          Read more about the Director positions

          Preference will be given to candidates who are available to start this afternoon. :-)

  5. EoinW

    The comment about credit unions is appropriate. When the next crisis hits the big five chartered banks will be protected by government legislation(bail-ins, if necessary) however the credit unions will be left to fend for themselves. Ultimately our banking cartel achieves its goal, eliminating all competition. Thus they profit handsomely from the real estate bubble and know that when it pops they’ll further benefit from the catastrophe which follows. Win-win. Predictable seeing they own the government.

  6. Matt Alfalfafield

    Speaking anecdotally, the rental market in Toronto is reaching a boiling point. I live in a formerly low-income neighborhood with dozens of small (ten-storey and under) apartment buildings not far outside the downtown core. Rents on my street for vacant apartments have increased by 60% in the four years I’ve lived here. There’s no way we could afford to move in where we are today. Hell, we couldn’t find anything at the same price even twice the distance from downtown.
    The company that owns our building has applied to the government for permission to increase our rent by triple the rate of inflation for the past few years, and despite efforts in our building to block them, the increases have gone ahead each time. Meanwhile, the state of repair in many buildings has declined. About two hundred people in the neighborhood got together and launched a rent strike, which started yesterday. Not sure they’ll get very far with it – yhe building management company is in a strong legal position – but it’s a sign of some serious frustration. And Ontario’s new real estate controls won’t do anything for people in our situation – rent control will still only apply to occupied units, and landlord will still have lots of ways to increase rent above the allowed amount.

  7. justanotherprogressive

    I’m a little confused here. Why would a pension plan loan any money (much less $2 B) to a failing corporation that also has serious fraud charges leveled against it?

    I wonder how this will all play out. Did Canada learn nothing from the worldwide examples of the past decade? Ah, I guess this time it is different?

    1. Elrond Hubbard

      Because HCG has pledged collateral (in the form of mortgages) worth 200% of the value of the loan, and in the meantime HOPP collects interest both on the amount borrowed and a lesser amount of interest on the as-yet-unborrowed balance.

      And because one of the board members (up until last week) of the failing corporation also happens to be director/CEO of the pension plan in question (see Northeaster’s link above). He may have seen a nearly can’t-lose opportunity just drop into his lap, at the expense of creditors.

  8. Wisdom Seeker

    “Why would a pension plan loan any money (much less $2 B) to a failing corporation that also has serious fraud charges leveled against it?”

    Did you catch that the head of the pension plan is also on the board of the failing corporation? And that the loan is secured by twice the value in underlying assets? And that the interest rate on the loan is apparently higher than the mortgage rates? They are asset-stripping the dying corporation while pretending to keep it healthy a little longer.

    “I wonder how this will all play out.”

    Since the cash flow on the mortgages won’t pay for the loan, either the company is restored to health by other means (and then pays off the loan), or else it goes broke. If the latter, the pension lender gets a ton of mortgages at half price, at the expense of prior shareholders and creditors who can now expect a much smaller recovery.

    1. justanotherprogressive

      Yea, I caught all that….

      The pension fund obviously believes that they will get $4B worth of mortgage assets…..wonderful! Great move, huh?

      But that belief is predicated on two pretty risky assumptions, isn’t it?

      Assumption 1) The price of housing will stay stable or increase. There are already many stories about Canada’s housing market being overheated….sooo….what goes up doesn’t go down in Canada? Exactly how much is that book value of $4B actually worth? How much will it be worth in a year or two?

      Assumption 2) I am reminded of a quote attributed to Louis Ranieri in “The Big Short”:
      “These are mortgages! And who the hell doesn’t pay their mortgage?” Remember these are sub-prime loans…….

      You forgot to mention how this all plays out if there is contagion……

      I think I will just continue to keep watching……

      1. Alex Morfesis

        Steve Munchin did the same thing and ended up trez secret airee…must be the new climb the ladder thingee amongst the puppeteers…2east funding corp and the theory of…

      2. HotFlash

        “These are mortgages! And who the hell doesn’t pay their mortgage?”

        Well you see, it’s the dollars or the domicile. Most people will probably pay their mortgages, we do not have srs unemployment here like you USians do, so yeah, the pmts will be made, by and large. So, that’s the dollars, for HOOPP. As to the foreclosures, that works too:

        1.) Toronto, for instance, has mostly brick buildings (we had this fire a while ago…). The houses and shops that are 150+ yrs old, such as mine, are *eminently* restorable, even if they have been neglected for decades.
        2.) Larger plots are most desirable, you can tear down the houses and build condos! So, if you have a *bunch* of mortgages, and they all default, then you have a building opportunity! Think of it as arson by financial means. My little area is very desirable, as we are close to Lake Ontario and 17 story condos will have a lake view — until they sell the same lake view to suckers in a new building just to the south of the first one. Which they do all the time.
        3.) How it actually shakes out, IMHO, will depend on the compensation plans. If they get bonuses for properties acquired, be sure that is what will happen, one way or another.

  9. Tom Stone

    It’s hot money so that makes sense, and it’s going to affect US Markets as well, particularly Florida and California.
    I expect the correction here in Sonoma County to be fast as well, but don’t expect it to start until Fall or perhaps next Spring.
    People have skin in the game this time, it’s going to hurt.
    A 30% decline it the median price over 3-4 years seems about right.

    1. Jim Haygood

      You may be right, Tom. Things are getting a little frothy in the usual US precincts.

      But Canada is a whole other ballgame. While the US Case Shiller index, adjusted for inflation, remains 16% below its July 2006 high, Canadian housing is about 30% above its 2006 level, inflation adjusted. [Putting a more precise value on this estimate is left as an exercise for Canadian readers.]

      On valuation ratios which compare housing prices to rents and income, Canadian housing is much more costly than the US:

      Who put the pin to Canada’s housing bubble? Economic historians will debate this question for decades to come.

      But in the rough justice of popular opinion, Ontario’s premier Kathleen Wynne may go down as the Canadian Herbert Hoover.

  10. HotFlash

    Credit unions in Canada are chartered provincially, and are protected by provincial deposit insurance legislation, such as the Deposit Insurance Corporation of Ontario (DICO). The current limit is $100,000, but it is going up to $250,000, at least here in ON.

    Edit: this was supposed to be a reply to EoinW May 2, 2017 at 9:32 am.

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