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Home Capital no ‘canary in the coal mine’: Scotia

Home Capital Group CEO Gerald Soloway.

Scotia Capital upgraded Home Capital Group Inc. towards the equivalent of a buy rating carrying out a steep 25 % drop a week ago.

Home Capital Group’s stock saw a bounce Monday following the upgrade, trading up 2.13 per cent, or 68 cents, to $32.54 by noon. Regardless of the bounce, short curiosity about the stock remains strong, with nearly one in four shares on loan.

Phil Hardie, analyst with Scotia Capital, asserted the growing short position – which he notes is primarily from U.S. investors – appears to be an overreaction to the bad news released earlier this month.

“While the near-term growth and investment thesis is challenged, with HCG now trading near trough multiples we believe the stock is oversold while offering an attractive reward,”?said Phil Hardie, analyst with Scotia Capital.

Last week’s tumble in share price occurred after the company asserted it had cut ties with a number of brokers, and that new mortgages had significantly missed analyst expectations within the second quarter.

Home Capital didn\’t explicitly state what resulted in the broker terminations and also the exact number of brokers cut lose, which led the short Canada crowd to pile in after questions were raised about the potential for higher loan-losses in the coming quarters.

Hardie said that while the questions about the impact on Home Capital are valid, he doesn\’t see this as proof of a Canadian housing market implosion.

“Concern here is whether this is the canary in the coal mine, or an isolated issue,” he said. “From what we should heard from speaking with others within the industry we believe this is quite isolated. It likely relates to a specific GTA broker platform that was largely focused on non-prime but also mixed up in prime insured business.”

Hardie said he doesn\’t expect other players in the Canadian mortgage sector -Equitable Group Inc., Genworth MI Canada Inc., or First National Financial Corp – to be prone to the news. Nonetheless, short sellers may be drawn to those names within the near-term on bets that Home Capital’s troubles are more systemic.

“This can be a development the housing shorts were hoping to find, in that it undermines the confidence in the excellence of the broker business and will also be positioned as a canary in the coal mine as proof of the cracks beginning to show within the Canadian mortgage market,” he said. “This will likely weigh on sector sentiment C but we do not see a strong fundamental read-through.”

Home Capital will announce earnings on July 29, followed by an earnings ask July 30. Hardie said he expects management to “soothe nerves” in regards to what happened with the terminated brokers, and assure investors there won’t be any credit events associated with the cut off.

Hardie currently includes a 12-month price target of $42 on Home Capital, implying about 30 percent upside from current levels.