Topic: How To Invest

Home Capital turns risky mortgage loans into big profits

Home Capital turns risky mortgage loans into big profits

HOME CAPITAL GROUP INC. (Toronto symbol HCG; gets 90% of its revenue by making residential mortgage loans to borrowers who don’t meet the stricter standards of larger, traditional lenders, like banks. These clients include recent immigrants with limited credit histories, and self-employed individuals.

The remaining 10% of Home Capital’s revenue mainly comes from credit cards and other loans to consumers and businesses.

Even though Home Capital caters to riskier borrowers, it avoids huge credit losses by identifying problem loans early. It then uses this information to restructure a borrower’s repayment terms and adjust its lending policies.

The company also cuts its risk by selling its mortgages to third parties. Moreover, Home Capital keeps its mortgage loans below 80% of a property’s market value.

Home Capital raises money for its loans through its six branches in major Canadian cities. These outlets offer traditional banking services, including savings accounts and retirement savings plans.

Canadian stocks: Home Capital shifting toward more profitable traditional mortgages

Thanks mainly to low interest rates, which continue to fuel loan demand, the company’s revenue jumped 95.2%, from $454.7 million in 2008 to $887.7 million in 2012. Earnings rose 103.8%, from $3.13 a share (or a total of $108.7 million) in 2008 to $6.38 a share (or $222.0 million) in 2012.

In the three months ended June 30, 2013, Home Capital’s earnings rose 16.3%, to $61.9 million, or $1.77 a share. A year earlier, it earned $53.2 million, or $1.54 a share. Revenue gained 6.3%, to $232.6 million from $218.8 million.

Home Capital set aside $4.4 million to cover future loan losses in the latest quarter, up 92.7% from $2.3 million a year earlier. That’s mainly because the company is shifting toward more profitable traditional mortgages that are not insured by the Canada Mortgage and Housing Corp.

The company’s efficiency ratio (non-interest expenses divided by revenue—the lower, the better) worsened, to 28.6% from 27.8%. That’s because it hired more employees to handle rising loan demand, which pushed up its costs.

The company has increased its dividend 16 times in the past nine years. The current annual rate of $1.12 a share yields 1.6%.

In the latest edition of The Successful Investor, we look at the added risk of Home Capital compared to other financial institutions, and whether it will be able to minimize its bad loans as it shifts its mortgage focus. We also look at the company’s financial outlook for next year, and whether it can keep raising its dividend. We conclude with our clear buy-sell-hold advice on the stock.

(Note: If you are a current subscriber to The Successful Investor, please click here to view Pat’s recommendation in the latest issue. Be sure to log in first.)

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow members

It seems clear that Home Capital is benefiting from today’s historically low interest rates. When you’ve owned stocks that are sensitive to one changeable factor (like interest rates or commodity prices) what approach has worked best for you? Getting rid of the stock when that factor changed for the worse? Or holding it because you believed the stock would pay off in the long run?


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