Home Capital — the mortgage lender bailed out by Buffett — is being bought by Smith Financial

by Bailey Amber
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It survived a regulatory probe, short-seller campaign and partial bank run

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Home Capital Group Inc., the Toronto-based alternative mortgage lender that survived a regulatory probe and short-seller campaign before being bailed out by Warren Buffett’s Berkshire Hathaway in 2017, is being acquired by Smith Financial Corp. in a deal that values the company at $1.7 billion.

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The $44-per-share offer from the company controlled by Canadian businessman Stephen Smith represents a 63 per cent premium to Friday’s closing price and a 72 per cent premium to the 20-day volume-weighted average trading price.

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If finalized, the deal will put two of Canada’s largest alternative lenders under the same umbrella: Smith, chair and co-founder of non-bank lender First National Financial LP, is also the largest shareholder of EQB Inc., formerly Equitable Group Inc., which provides residential and commercial real estate lending services and personal banking. He owned or controlled nearly 19 per cent of EQB’s voting shares through private holding companies, according to an April regulatory filing.

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In the run-up to the proposed acquisition by Smith’s group, shares of Home Capital shares had declined as it faced rising interest rates and looming renewals of a large chunk of the mortgages on its books. In August, the company said it had rebuffed an approach from an unnamed buyer because the price offered was too low.

But the stock had climbed back significantly from the company’s rockiest years between 2015 and 2017.

During that period, the company lost its long-time chief executive Gerry Soloway, who was at the helm when an internal probe revealed some 45 brokers had falsified employment and income information used to support a large proportion of mortgage applications, and had also falsely documented completion of income verification.

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The brokers were let go, but Home Capital “misled” shareholders for months about the reasons for a decline in mortgages originations that followed, according to a 2017 settlement with the Ontario Securities Commission.

Prior to the run-in with regulators, Home Capital was well-regarded, one of Canada’s largest near-prime or alt-A mortgage lenders, extending mortgages to those who did not qualify for the rates offered by the country’s big banks. Home Capital secured a niche serving the self-employed and immigrants who did not yet have a significant credit history in this country, funded by a thriving deposit business.

When the OSC made allegations of misleading disclosure against the company in the spring of 2017, customers began to pull deposits from Home Capital’s high-interest savings accounts and GICs, which helped fund the company’s mortgage lending.

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The partial bank run caused Home Capital to take $2 billion in rescue financing at high interest rates, raising questions about its viability.

Some company observers, including Jim Keohane, who was at the helm of the Healthcare of Ontario Pension Plan (HOOPP) when it extended the $2-billion lifeline to Home Capital, viewed the upheaval as overblown, given that many of the troubled mortgages would have rolled off the books by the time the OSC levelled allegations against the company.

But California-based short-seller Marc Cohodes, who had invested in Home Capital in 2014 after concluding the shares were potentially overvalued, carried out a vocal campaign suggesting a plunge in the company’s share price following the OSC’s allegations was only the beginning.

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In June of 2017, Home Capital agreed to pay $30.5 million to settle both OSC allegations of misleading disclosure and a class-action lawsuit in a dual agreement that appeared to be designed to help salvage the troubled mortgage lender as a going concern or viable takeover target.

Also that month, Buffett’s Berkshire Hathaway replaced Home Capital’s emergency $2-billion credit facility and took a 19.9 per cent stake in the mortgage lender. A bid to nearly double that stake was, in a surprise turn of events, rejected by Home Capital shareholders that September. 

The following year, with the loan repaid, Buffett declared he would “substantially exit” his position in the Canadian firm, saying the stake was “not of a size to justify our ongoing involvement.”

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With the regulatory tangle behind it and a new slate of executives, the company moved on, setting out a strategic plan in 2019 that included digitizing operations. The shares began to rebound, dipping again only in the early days of the COVID-19 pandemic.

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The acquisition of Home Capital by Smith Financial is expected to close in mid-2023, subject to regulatory approvals. The company’s board of directors unanimously approved the transaction, which it concluded is in “the best interest of Home Capital and is fair to its shareholders.”

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Directors and senior officers have entered into voting support agreements with the buyer, agreeing to vote all of the common shares they own or control in favour of the acquisition.

However, a “go-shop” period through Dec. 30 will allow Home Capital to “actively” solicit, evaluate and enter into negotiations with anyone else interested in acquiring the company, with Smith Financial retaining a “right to match” at the end of that period.

Jaeme Gloyn, an analyst at National Bank Financial, said he believes the deal will go ahead as planned despite the go-shop period, based on the size of the bid and the buyer.

“My initial guess (for the unnamed suitor) in August was Fairstone Financial, which is owned by Stephen Smith so I doubt he outbids himself,” said Gloyn.

Other potential buyers include the “usual suspects” such as Onex Corp., Fairfax Financial Holdings Ltd., and Brookfield Business Partners L.P., he said, but he thinks they are “unlikely to pay more.”

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