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May 31, 2017

Canada's private lenders feast on Home Capital scraps

A sign shows the logos of Home Capital Group's subsidiaries Home Trust and Oaken Financial.

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TORONTO - The struggles of Canadian lender Home Capital Group (HCG.TO) are pushing more borrowers toward less regulated mortgage providers, raising the risks for them and the wider property market.

Lenders not supervised by Canada's main financial regulator already account for around 15 percent of new mortgages in Canada and Home Capital's near-collapse five weeks ago has seen some of them inundated with more new business.

"Private lenders are taking the deals now turned away by Home Trust," said Louis Glazer, a Montreal-based mortgage broker who specializes in loans from non-bank lenders.

Home Capital, Canada's biggest non-bank lender, was typically the first port of call for would-be borrowers who did not meet banks' more stringent lending criteria. Their customers were often self-employed or recent immigrants who lacked sufficient credit history or a guaranteed income.

In recent weeks, it has scaled back on lending to focus on repairing its balance sheet following rapid deposit withdrawals after a management shake-up and accusations brought by a regional regulator that it had mislead investors about its mortgage business.

Home Capital has denied the accusations and, in a statement emailed to Reuters, said it was continuing to originate mortgages but had tightened its lending criteria.

As a result, many would-be clients are instead turning to private lenders, most of whom pool their funds together into entities called Mortgage Investment Corporations (MICs), brokers say.

Unlike Home Capital, which is regulated by Canada's main financial watchdog and has nearly half of its loans covered by government insurance schemes, MICs have no government backstop and are only overseen by their provincial regulator. They are primarily funded by wealthy individuals and families, endowment and pension funds and wealth managers - a source of funding that could quickly dry up if market conditions worsen.

Home Capital's woes have prompted private lenders to seek higher rates of return. That and the increased demand has already led to higher interest rates.

Guy Lew, a mortgage broker at CENTUM Metrocapp Wealth Solutions said rates have risen by up to 25 per cent to between 7 per cent at the lowest end of the scale on a first mortgage and up to 19 percent for a second loan.

Those rate increases could have a wider knock-on effect given the degree to which Canadian borrowers rely on the alternative lending market.

Home Capital estimates that about 25 to 30 per cent of Canadian borrowers require alternative funding at any given time, meaning the overall market for alternative lenders could be worth between $350 billion and $420 billion out of a total $1.4 trillion residential mortgage market in Canada. This segment of the market has grown rapidly since the 2008-2009 financial crisis as low interest rates and rising home prices encouraged Canadians to take on more debt.

The government and regulators have tightened mortgage lending rules repeatedly in a bid to curb risky lending.


However, strict lending criteria at the country's 'big six' banks mean a missed payment or change of employment could make otherwise creditworthy customers require alternative financing, boosting business of the less regulated lenders.

"If you want to look at the unintended consequences of policies and what's happened now with Home Capital I think you will see the MIC market mushrooming." Said Benjamin Tal, deputy chief economist at CIBC. "You will see more and more activity going through to MICs."

Canadian authorities and the nation's leading banks have played down concerns that Home Capital's troubles could spill over into the wider market, arguing that it only accounts for 1 percent of the overall mortgage market.

In fact, the ripple effect of pricing out borrowers with uncertain income could help Canadian authorities negotiate a soft landing for the housing market – something they have been trying to accomplish by tightening mortgage underwriting rules and introducing foreign buyers' taxes in Toronto and Vancouver.

But driving more borrowers into a lightly regulated sector with an unstable source of funding also creates new risks, particularly given private lenders' role in supplying Canadians with second loans against their home at a time when household debt is already at a record high.

"We're transferring the risk from the regulated segment of the market to the unregulated segment, said CIBC's Tal. "I really don't think it's a good thing."

The Office of the Superintendent of Financial Institutions, the main national regulator, said it was monitoring the situation.

"Whenever there are conditions or events that impact that environment and potentially increase risks, our level of activity and vigilance increases," it said in an emailed statement.