HOME CAPITAL INC.: Growth the Banks Don't Want

Shareowner, Mar/Apr 2005

Home Capital is a federally-regulated trust company and Canada's largest provider of residential mortgages to individuals who have been turned down by major lending institutions (e.g. banks). Typical customers include: self-employed entrepreneurs; people re-establishing credit; new immigrants; and, those who are newly employed.

Historical & Future

Growth Prospects

Patient, long-term investors typically want to purchase stocks that have strong prospects for increasing their price over the next five years. Knowledgeable investors know that, over the longer term, a stock's share price can experience sustainable growth only if the company's earnings per share (EPS) do; and, EPS can only experience sustainable growth if the company's revenues do too.

Accordingly, the natural place to begin studying a stock's potential for price appreciation is with the company's potential-to-grow revenues.

Here, we begin with developing an understanding of the company's products and their potential for being sold in increasing quantity during the next five years.

Revenues

For the purpose of studying this financial institution (and most others where interest receipts and payments are the principal inflows and outflows of cash), revenues are defined as:

Net Interest Income

+ Non-Interest Income

- Provisions for Credit Losses

As indicated by the Home Capital's Revenue Profile (opposite page), growth has averaged a quite consistent 36% annually since 1998. During the last three years, revenue growth accelerated to 43% with revenues reaching an estimated $112 million for the fiscal year ending December 2004.

Important Products

Home Capital operates two businesses: (1) deposit taking and mortgage lending; and, (2) retail credit services and credit card issuing services.

Mortgages

(78% of 2004 revenues vs. 85% in 2000) Home Capital has over $2 billion in loans (principally mortgages) outstanding which are offset with deposits and borrowings of approximately $2 billion. The mortgage portfolio is 97% residential - virtually all in first mortgages.

To contain risk, Home Capital supplies first mortgages only up to 75% of a residential property's value.

The company establishes new clients through: (1) an extensive network of mortgage brokers: and, (2) referral relationships with a number of Canada's major lending institutions.

Home Capital funds its mortgage lending principally with investment deposits (including guaranteed investment certificates, term deposits and retirement products). The company's ability to attract deposits depends largely on the interest rate it offers.

Home Capital is licensed to conduct business across Canada (except Quebec). Deposits are accepted at the company's six locations: Ontario (3), Alberta (1), British Columbia (1) and Nova Scotia (1).

As well, the company has working relationships with hundreds of deposit brokers and investment dealers.

To augment its principal financial resource (i.e. deposits) for providing additional mortgages, Home Capital combines and sells its existing mortgages as securities (see securitization sidebar).

This practice further assists growth in the mortgage-lending business without corresponding increases in the company's regulatory capital.

Complimentary Businesses (22% of 2004 revenues vs. 15% in 2000)

Home Capital's VISA card is available to individuals who wish to establish or re-establish their credit worthiness. The Equity Plus VISA card (introduced in 2002) provides homeowners access to $10,000 - $100,000 of equity in their homes with a relatively low interest rate (12%-15%). Because the credit is secured against the cardholder's home equity, the card represents a type of mortgage with a fairly secure and high interest margin.

Important Competitors

Home Capital competes with banks, trust companies, private lenders and other deposit-taking institutions. Chief competitors include other low-value mortgage lenders like ING Direct, MCAP Inc. (MKP on the TSX) and Maple Trust. Home Capital is currently the largest provider of residential loans to borrowers turned away by other lenders.

Important Influences on Future Revenue Growth

Booming Real Estate Market

Future growth in the company's revenues is expected to be driven by the continuing 'boom' in the Canadian residential housing market. That demand is generally attributed to: historically-low and affordable interest rates; steady demand from the younger cohorts of Canadians buying starter homes and older cohorts downsizing; and, recent and projected population growth in several of the company's geographic business areas. The company considers its niche market - those who typically have difficulty obtaining mortgages from traditional lenders - as under-served and still very large.

Historically, the value of mortgages is much more stable than housing prices. That is, mortgage values do not fluctuate as widely as housing prices.

In the event of declining house prices, Home Capital's mortgages are well collateralized with an average loan-to-value ratio of 66%.

Complimentary Products