I find alternative lenders like Home Capital Group (TSX:HCG) to be fascinating case studies in how financial markets work. In particular, the alternative lending sector is one, which in theory at least, should boom in bull markets and bust in bear markets.
However, I’m now considering how the Bank of Canada’s recent decision to increase its purchase of Canada Mortgage Bonds (CMB, the equivalent of mortgage-backed securities in the U.S.) will affect Home Capital’s CMB generation as a mortgage originator.
What many investors may not know is that Home Capital, and most other alternative lenders in Canada, do not hold most of the risk of the loans that these companies produce for very long. These higher-risk, higher-interest rate mortgages made to immigrants or those with low, poor or no credit due to being self-employed, etc. are packaged up into Canadian Mortgage Bonds (CMB) products which are now being bought heavily by the Canadian government via the Bank of Canada.
This means that companies like Home Capital can continue to generate and originate new loans at a faster rate without worrying too much about the underlying credit of these mortgages, which are flipped, in relatively short order, to the Bank of Canada. The Bank of Canada then assumes this risk.
In other words, Home Capital’s origination fees can theoretically be considered “risk-free,” as long as the Bank of Canada continues to buy these CMB products at a rate relatively equivalent to alternative lending demand.
That said, if this recession turns into a full-blown depression, mortgage origination is likely to be forced to cease, as most low-paying jobs will cease. Companies like Home Capital simply won’t be able to originate loans due to the reality that most of the population won’t be able to meet the minimum criteria necessary to qualify for such loans.
Invest wisely, my friends.