DBRS Limited (DBRS Morningstar) upgraded the long-term ratings of Home Capital Group Inc. (HCG or the Group) to BBB (low) from BB (high) and upgraded the Group’s short-term ratings to R-2 (middle) from R-3. DBRS Morningstar also upgraded the long-term ratings of HCG’s primary operating subsidiary, Home Trust Company (HTC or the Trust Company), to BBB from BBB (low) and upgraded the Trust Company’s short-term ratings to R-2 (high) from R-2 (middle). Additionally, DBRS Morningstar changed the trends on all ratings to Positive from Stable. The Intrinsic Assessment (IA) for HTC was raised to BBB from 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
The rating upgrades and positive trends reflect the continued positive momentum of HCG’s franchise and earnings that have resulted in both an improved Scorecard and Grids assessment. The Group is successfully implementing its strategic plan, which is very much aligned with its core strengths and includes investments in technology to further improve service to clients and brokers while enhancing efficiencies. HCG has made significant strides in regaining its position in the mortgage finance industry, particularly as a leader in the Alt-A space. Furthermore, HCG continues to diversify its funding sources and improve its liquidity position. While the ratings reflect HCG’s good asset quality and history of low impairments and charge-offs, the ratings also consider the Group’s concentrated business model in the Alt-A space and residential real estate in general. DBRS Morningstar notes that government support measures have largely mitigated the negative impacts of the Coronavirus Disease (COVID-19) pandemic. Positively, economic performance has rebounded and the labour market has approached full capacity despite the remaining uncertainties related to the pandemic, high household debt levels, and housing market imbalances.
The Bank’s IA is positioned below the Intrinsic Assessment Range (IAR) because of HCG’s concentrated business model, which makes it susceptible to adverse changes in the Canadian real estate market. DBRS Morningstar remains concerned about the combination of highly leveraged consumers and elevated home prices, particularly in the greater Toronto and Vancouver areas, and believes that housing prices remain vulnerable.
Making further progress to diversify funding sources with continued strong financial performance would lead to a ratings upgrade.
Conversely, a ratings downgrade would occur if there is substantive funding pressure caused by deposit outflows or if disproportionate growth in commercial originations increases HCG’s risk profile. Furthermore, if there are significant losses in the loan portfolio, especially as a result of unforeseen weakness in underwriting and/or risk management, the ratings would also be downgraded.
Franchise Combined Building Block (BB) Assessment: Moderate/Weak
HCG is one of Canada’s leading Alt-A mortgage providers for borrowers who are self-employed, new immigrants, or recovering from bruised credit. Residential Alt-A mortgages formed around 64% of the Group’s $18.4 billion loan portfolio as of December 31, 2021. At the onset of the coronavirus pandemic, the various lockdowns had a disproportionately negative impact on small businesses and those who are self-employed; however, government aid programs have helped to mitigate some of the impact. The current economic environment has translated into healthy growth in its volumes for HCG, particularly within its core customer base. Originations rose by 27% from the previous year end to $8.9 billion in F2021, while loans under administration increased by 5% to $24.2 billion.
Earnings Combined Building Block (BB) Assessment: Good/Moderate
The Group recorded strong performance in F2021 as higher volumes and margins were buoyed by a year of reversals of provisions for credit losses (PCL). Owing to its dominant Alt-A portfolio, HCG benefits from a unique trend where mortgages do not reprice as fast as deposits. As such, in a low interest rate environment the Group’s net interest margin (NIM) performed better than its peers. HCG’s NIM rose by 10 basis points in F2021 to 2.56% that, coupled with increasing volumes, led to a 4% increase in net interest income to $494 million, a record level for the Group. Similar to other banks, HCG reversed most of the Stage 1 and Stage 2 PCL taken in the previous year as a mitigant to potential losses caused by the pandemic. DBRS Morningstar expects PCL to normalize going forward.
Risk Combined Building Block (BB) Assessment: Strong/Good
HCG’s asset quality continues to be strong, with loan impairments forming just 0.17% of gross loans in F2021 versus 0.68% in F2020 (according to DBRS Morningstar calculations). These levels are very low compared with historical trends as government stimulus during the pandemic has created a boon in the economy, particularly in the housing sector where prices are rising rapidly. As a result, borrowers would tend to sell their property to resolve their situation rather than default on their mortgages. However, DBRS Morningstar expects impairments to normalize toward historical levels in the short to medium term.
Funding and Liquidity Combined Building Block (BB) Assessment: Good/Moderate
Although on a downward trend, the Group continues to be highly dependent on broker-sourced deposits, which comprised a still high 68% of its $14.0 billion total deposits at December 31, 2021. Positively, HCG is growing its direct-to-consumer channel through its Oaken Financial offering, and directly sourced deposits have increased 11% year over year to $4.4 billion. Additionally, in an effort to further diversify funding, the Group launched two separate private placements of residential mortgage-backed securities funded by uninsured single-family mortgages which totalled $765 million, and participated in a bank-sponsored securitization conduit with a $287 million placement of uninsured single family mortgages. HCG continues to use the various securitization programs run by Canada Mortgage and Housing Corporation (rated AAA with a Stable trend by DBRS Morningstar).
Capitalization Combined Building Block (BB) Assessment: Strong/Good
HTC’s CET1 ratio was a strong 18.4% in F2021 but down from 19.8% as at YE2020. In Q1 2022 the Group will commence paying dividends for the first time since 2017, announcing a $0.15 per share cash dividend as the Office of the Superintendent of Financial Institutions lifted the pandemic-related moratorium on dividend increases and share buybacks. Furthermore, the Group launched a Substantial Issuer Bid and renewed its Normal Course Issuer Bid. Management expects to manage capital to a range of 14% to 15% by balancing business growth opportunities with returns to investors.
Further details on the Scorecard Indicators and Building Block Assessments can be found at: https://www.dbrsmorningstar.com/research/394285.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
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.
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