DBRS Morningstar Confirms Ratings on Home Capital Group Inc. at BB (high) and Home Trust Company at BBB (low), Changes Trends to Negative

DBRS Limited (DBRS Morningstar) confirmed the long-term ratings of Home Capital Group Inc. (HCG or the Group) at BB (high) and the Group’s short-term ratings at R-3. DBRS Morningstar also confirmed the long-term ratings of HCG’s primary operating subsidiary, Home Trust Company (HTC or the Trust Company), at BBB (low) and the Trust Company’s short-term ratings at R-2 (middle). Additionally, DBRS Morningstar changed the trends on all ratings to Negative from Stable. The Intrinsic Assessment (IA) for HTC is BBB (low) while its Support Assessment is SA1. HCG’s Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below HTC’s IA.

KEY RATING CONSIDERATIONS
DBRS Morningstar changed the trends on all ratings to Negative to reflect the anticipated adverse impact of ongoing uncertainty regarding future economic conditions caused by the Coronavirus Disease (COVID-19) pandemic on HCG. Business closures to halt the spread of the coronavirus continue across Canada and are having significant effects on employment, particularly for smaller firms and entrepreneurs, many of whom represent Alternative-A (Alt-A) borrowers. DBRS Morningstar is concerned that these interruptions will have a significant impact on the performance of HCG’s Alt-A residential mortgage portfolio and new origination volumes. Furthermore, the Negative trend also considers HCG’s commercial lending portfolio, which will also likely experience stress as economic activity is reduced and construction projects are disrupted.

RATING DRIVERS
Given the Negative trend, a ratings upgrade is unlikely at this time. DBRS Morningstar could change the trend back to Stable if the impact of the current economic environment on HCG’s earnings and credit quality metrics is manageable.

Conversely, material losses in the loan portfolio resulting from a prolonged adverse coronavirus-related impact or significant pressures on funding and liquidity would result in a ratings downgrade.

RATING RATIONALE
HCG is one of Canada’s leading Alt-A mortgage providers for borrowers who are either self-employed, new immigrants, or recovering from bruised credit. Residential Alt-A mortgages formed around 63% of the Group’s $17.3 billion loan portfolio as of December 31, 2019. The current economic situation is having a disproportionately negative impact on small businesses and those who are self-employed. As a result, DBRS Morningstar believes that demand for Alt-A mortgages will be materially affected, leading to lower origination volumes for HCG in 2020. For 2019, HCG originated $1.6 billion of Alt-A mortgages.

Given the economic climate and the prevalence of Alt-A mortgages in its portfolio, DBRS Morningstar is also concerned that HCG might receive proportionally higher applications for loan deferrals than larger banks. Furthermore, a particular nuance of Alt-A mortgages is their short renewal terms, which average 18 months to 24 months. This implies that HCG will see a larger proportion of its borrowers seeking mortgage renewals in any year versus the more diversified banks. Lost jobs and reduced income related to the coronavirus increases credit risk as borrowers may be unable to renew their mortgages with HCG or find alternative lenders to which they can transfer their mortgages. In addition, the current restrictions on real estate transactions caused by the social distancing measures will pose challenges for HCG in cases where it needs to efficiently foreclose on a property, therefore potentially driving up impaired loans on the Group’s balance sheet and leading to increased write-offs. Meanwhile, HCG’s uninsured commercial loans of $1.9 billion represented 11% of its on-balance sheet portfolio at the end of 2019. This portfolio could face challenges, particularly the construction loans, if government actions to control the spread of the coronavirus lead to halts in construction as well as pressure on tenants to meet rental payments.

DBRS Morningstar views HCG’s funding and liquidity positions as stable, especially given the Trust Company’s access to some Canadian federal government liquidity programs. Nevertheless, tightening market conditions are widening spreads and making access to wholesale and brokers deposits more expensive; therefore, despite the Group’s cost containment and efficient operations, the economic deterioration and associated higher funding costs on wholesale and brokered deposits will likely depress revenue and profitability. Furthermore, although capitalization levels are sound with the Common Equity Tier 1 ratio of 17.6% as of Q4 2019, pressures on profitability and a potential increase in credit losses will likely result in lower capital levels over the medium term.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for HCG are as follows: Franchise Strength – Moderate; Earnings Power – Moderate; Risk Profile – Good/Moderate; Funding and Liquidity –Moderate; and Capitalization – Moderate.

DBRS Morningstar notes that the above press release was amended on April 27, 2020, to correct the ratings in the table for Home Trust Company’s Long-Term Issuer Rating, Long-Term Deposits, and Long-Term Senior Debt to BBB (low). The table is now correct.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 11, 2019).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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