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Settlement Generates Confidence in Subprime Mortgages

Home Capital Group surprised the markets when it announced it reached a settlement to pay $30.5 million to settle allegations from the Ontario Securities Commission (OSC) and a class-action lawsuit.1 The move should help save the beleaguered mortgage lender and breathe life back into the subprime mortgage industry.On June 14, Home Capital Group Inc. said it agreed to pay a total of $30.5 million to settle OSC allegations and a class-action lawsuit. Brenda Epril, the company’s board chairwoman said it ‘will accept full responsibility for failing to meet its disclosure obligations.”The settlement with the OSC stems from accusations back in April that Home Capital mislead investors about an internal probe in 2014 and 2015 over falsified income documents used for real estate loans. The company cut ties with 45 brokers over the cooked mortgage applications.Home Capital’s share price was rocked when allegations that Home Capital mislead investors surfaced in April. Shares in the Toronto-based company plunged approximately 80% from around $24.00 per share in the middle of the month to a low of around $5.00 per share in early May.As a major lender to subprime borrowers (those who have been rejected by the big banks for a mortgage because they don’t meet their strict lending rules), the company had to secure a $2 billion credit line after depositors withdrew hundreds of millions of dollars from its high-interest savings accounts.The investigation by the OSC created an air of uncertainty about the company’s ability to continue to lend for mortgages. Even though the investigation was looking at events that took place more than two years earlier. And the underlying fundamentals of the company were solid.The company had no issues with credit or a capital shortfall. But because of investor uncertainty, the company’s share price was gutted. In fact, the collapse in Home Capital’s share price had nothing to do with the strength of the company.At the time, there were fears that a collapse of Home Capital would translate into higher mortgage rates for subprime borrowers. That’s because a lack of confidence in other non-bank lenders could make it difficult for these lenders to access funds. The funds they could access would come with higher costs which would be passed onto borrowers in the form of higher interest rates.News of the settlement should help Home Capital attract new funding at more reasonable costs. At the same time, news of the settlement created an immediate sense of confidence in the company’s stock. In the two days following the announcement, Home Capital’s share price surged almost 20% to around $14.40 per share.The company is still not out of the woods and needs the settlement to be approved. Home Capital also needs to find a new Chief Executive, and develop a long-term strategy. That said, some analysts are valuing the company’s share price at more than $25 per share, more than double the current level.2

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  1. “Home Capital Announces Agreements to Settle OSC and Class Action Matters,” Home Capital Group web site, June 14, 2017; http://www.homecapital.com/press_releases/2017/Press%20Release%20June%2014%202017.pdf.
  2. “Home Capital shares surge in wake of settlement,” Financial Post web site, June 15, 2017; http://business.financialpost.com/news/fp-street/home-capital-shares-surge-in-wake-of-settlement.