Home equity loan canada

Home Capital is a federally-regulated trust company and Canada's largest provider of residential mortgages to individuals who have been turned down by major lending institutions (e.g. banks). Typical customers include: self-employed entrepreneurs; people re-establishing credit; new immigrants; and, those who are newly employed.

Historical & Future

Growth Prospects

Patient, long-term investors typically want to purchase stocks that have strong prospects for increasing their price over the next five years. Knowledgeable investors know that, over the longer term, a stock's share price can experience sustainable growth only if the company's earnings per share (EPS) do; and, EPS can only experience sustainable growth if the company's revenues do too.

Accordingly, the natural place to begin studying a stock's potential for price appreciation is with the company's potential-to-grow revenues.

Here, we begin with developing an understanding of the company's products and their potential for being sold in increasing quantity during the next five years.

Revenues

For the purpose of studying this financial institution (and most others where interest receipts and payments are the principal inflows and outflows of cash), revenues are defined as:

Net Interest Income

+ Non-Interest Income

- Provisions for Credit Losses

As indicated by the Home Capital's Revenue Profile (opposite page), growth has averaged a quite consistent 36% annually since 1998. During the last three years, revenue growth accelerated to 43% with revenues reaching an estimated $112 million for the fiscal year ending December 2004.

Important Products

Home Capital operates two businesses: (1) deposit taking and mortgage lending; and, (2) retail credit services and credit card issuing services.

Mortgages

(78% of 2004 revenues vs. 85% in 2000) Home Capital has over $2 billion in loans (principally mortgages) outstanding which are offset with deposits and borrowings of approximately $2 billion. The mortgage portfolio is 97% residential - virtually all in first mortgages.

To contain risk, Home Capital supplies first mortgages only up to 75% of a residential property's value.

The company establishes new clients through: (1) an extensive network of mortgage brokers: and, (2) referral relationships with a number of Canada's major lending institutions.

Home Capital funds its mortgage lending principally with investment deposits (including guaranteed investment certificates, term deposits and retirement products). The company's ability to attract deposits depends largely on the interest rate it offers.

Home Capital is licensed to conduct business across Canada (except Quebec). Deposits are accepted at the company's six locations: Ontario (3), Alberta (1), British Columbia (1) and Nova Scotia (1).

As well, the company has working relationships with hundreds of deposit brokers and investment dealers.

To augment its principal financial resource (i.e. deposits) for providing additional mortgages, Home Capital combines and sells its existing mortgages as securities (see securitization sidebar).

This practice further assists growth in the mortgage-lending business without corresponding increases in the company's regulatory capital.

Complimentary Businesses (22% of 2004 revenues vs. 15% in 2000)

Home Capital's VISA card is available to individuals who wish to establish or re-establish their credit worthiness. The Equity Plus VISA card (introduced in 2002) provides homeowners access to $10,000 - $100,000 of equity in their homes with a relatively low interest rate (12%-15%). Because the credit is secured against the cardholder's home equity, the card represents a type of mortgage with a fairly secure and high interest margin.

Important Competitors

Home Capital competes with banks, trust companies, private lenders and other deposit-taking institutions. Chief competitors include other low-value mortgage lenders like ING Direct, MCAP Inc. (MKP on the TSX) and Maple Trust. Home Capital is currently the largest provider of residential loans to borrowers turned away by other lenders.

Important Influences on Future Revenue Growth

Booming Real Estate Market

Future growth in the company's revenues is expected to be driven by the continuing 'boom' in the Canadian residential housing market. That demand is generally attributed to: historically-low and affordable interest rates; steady demand from the younger cohorts of Canadians buying starter homes and older cohorts downsizing; and, recent and projected population growth in several of the company's geographic business areas. The company considers its niche market - those who typically have difficulty obtaining mortgages from traditional lenders - as under-served and still very large.

Historically, the value of mortgages is much more stable than housing prices. That is, mortgage values do not fluctuate as widely as housing prices.

In the event of declining house prices, Home Capital's mortgages are well collateralized with an average loan-to-value ratio of 66%.

Complimentary Products

The addition of credit cards to the company's product line is expected to provide further revenue growth, as the cards further penetrate Home Capital's wide client base.

As well, recently introduced (in 2003) second mortgages further expand the product line with a higher-margin product.

Capacity to Grow Revenues

Two Financial Fundamentals

Since 1994, Home Capital has expanded its total assets from some $370 million to an estimated $2 billion in 2004. This asset expansion has been financed principally by:

1) Retaining $130 million of earnings, which represents a 91% retention ratio in 2004 (Chart 1);

(2) Selling $10 million in long-term debt;

(3) Issuing $17 million of new equity; and,

(4) Spontaneous increases in short-term liabilities. Note that the company records its deposit and borrowings (which offset mortgage loans) as short-term liabilities.

Expanding assets with this financing mix has gradually reduced the company's reliance on debt from $1,604 of assets for every $100 of equity in 1998 to $1,455 in 2004 (Chart 2).

One Operating Fundamental

Chart 3 shows Home Capital's efficiency in generating revenues from assets increasing from $3 to $5 of revenues for every $100 of assets between 1998 and 2004.

Projected Revenue Growth

Home Capital's long history of successfully growing revenues; its very strong financial fundamentals; and, the abovenoted influences on future growth all suggest a considerable capacity to continue growing revenues.

Here, an illustrative A judgment was made to project future revenue growth of about 30% per year to approximately $415 million by 2009.

Capacity to Grow EPS

As indicated by the Stock Study Guide's EPS Profile, earnings (before discontinued, extraordinary, and special items) have grown very consistently at an average compound rate of 38% since 1998. Since then, growth has accelerated to the 40%-50% range with estimated 2004 EPS of $1.27 per share.

Home Capital has the distinction of having more consecutive fiscal quarters (37) of increasing EPS than any other public company in Canada.

Capacity to Grow Earnings

A Second Operating Fundamental

Home Capital's growth in EPS has generally kept pace with revenues, in part, because the company has increased its efficiency in: (1) generating revenues from assets (Chart 3); and, (2) in converting those revenues into earnings. Chart 4 shows earnings from every $100 of revenues increasing from $34.66 in 1998 to $39.75 in 2004.

Projected EPS Growth

The projected growth in Home Capital's revenue and the demonstrated ability of EPS to keep pace supports an illustrative A judgment to project EPS growth at an average rate of about 30% to approximately $4.72 in fiscal 2009.

Is the Stock "On Sale" or "Over-Priced?"

Price for $1 of EPS is Increasing. Chart 5A illustrates the historical relationship between growth in Home Capital's EPS and its High-Low price bars (blue) from 1998 to 2004. All of the prices have been indexed to EPS in 2001 (by dividing all prices by the average Price/Earnings ratio for 2001; namely, 9.3).

Indexing on 2001 shows the price bars: (1) before 2001 being generally below the EPS Profile; and, (2) those for 2002 and later generally above the Profile. This situation indicates an expansion (since 2001) of the price that investors are willing to pay for $1 of the company's EPS. That exhuberance for the stock has caused its price to grow much faster than EPS.

This stronger growth is clearly visible in the steeper rise in the price bars since 2001 than the rise in EPS. As a result, the stock's recent price of $33 is located significantly above the Projected EPS Profile which suggests significant Over-pricing' - in relation to the value of $1 of EPS in 2001.

Indexing on 2004. Chart 5B illustrates the situation where all the price bars have been indexed to EPS for 2004 - to reflect the most recent value of $1 of EPS (by dividing all prices by the average Price/Earnings ratio for 2004; namely, 19.4).