Fitch Downgrades Home Capital's IDR 'BBB-'; Outlook Revised to Stable

Wed Apr 2, 2014 1:32pm EDT

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(The following statement was released by the rating agency) NEW YORK, April 02 (Fitch) Fitch Ratings has downgraded Home Capital Group Inc.'s (HCG) and its subsidiary, Home Trust Company's (HTC), long-term and short-term Issuer Default Ratings (IDR) to 'BBB-/F3' from 'BBB/F2', respectively. With this action, the Rating Outlook has been revised to Stable from Negative. A complete list of rating actions follows at the end of this release. KEY RATING DRIVERS - IDRS, VRS AND SENIOR DEBT Today's rating action reflects HCG's historic and projected rate of loan growth; both of which have exceeded peer group medians and Fitch's expectations. Fitch views HCG's growth cautiously given the company's concentrated risk profile in the alternative single family mortgage space and the moderate overvaluation in the Canadian housing market. HCG primarily focuses on borrowers who do not qualify for prime mortgages offered by larger Canadian banks. Typical clients consist of self-employed individuals, small business owners, individuals with poor or limited credit histories, and newly arrived immigrants. While credit performance for HCG has remained strong over the last several years with net write-offs and net-nonperforming loans totalling only 0.09% and 0.35% of gross loans, respectively, as of year-end 2013, Fitch believes that should the Canadian market begin to exhibit some signs of housing market weakness these credit metrics could begin to deteriorate. Supporting this view is evidence that loans made to these types of borrowers typically carry a higher risk of default than mortgages insured by the Canadian Mortgage and Housing Corporation (CMHC). Furthermore, potential credit deterioration of HCG's loan portfolio is likely to weigh on the company's earnings and capital position, both of which have historically supported the company's ratings. HCG's earnings continue to be a relative strength for the company with returns on average assets and shareholder's equity totalling 1.3% and 23.9%, respectively, for 2013. However, the influence of earnings on HCG's ratings is tempered in the context of the company's outsized growth, concentrated risk position, and largely single product focus, which collectively have a higher influence on the company's ratings. Fitch notes that HCG's capital levels are well above required levels, with the Tier 1 and total capital ratios totalling 16.80% and 19.69%, respectively, and Fitch Core Capital (FCC) to risk weighted assets (RWA) totalling 16.76% at year end. Fitch views HCG's favourable capital position as supportive to the company's ratings and Stable Rating Outlook. However, given the company's moderately higher risk profile than other Canadian bank peers, Fitch believes that higher than peer group capital levels are also appropriate to absorb potential losses. While HCG's liquidity position improved over the last year, ratings continue to be constrained by HCG's reliance on high-cost, brokered time deposits and mortgage securitizations for funding. In particular, the brokered time deposits would be expected to experience run off (or at least a relatively higher funding cost) in a rising rate environment. HCG ending the year with more than $1.4 billion in liquid assets following a $300 million institutional deposit note issuance in late 2013. Fitch views HCG's level of liquidity as sufficient considering the company's limited funding structure. RATING SENSITIVITIES - IDRS, VRS AND SENIOR DEBT Positive rating momentum is not viewed as likely in the near- to intermediate term, due to geographic and product concentration, as well as HCG's monoline business model and limited funding mix, all set against the backdrop of elevated home prices and personal debt to income ratios within Canada. Longer-term, positive rating momentum would be dependent on HCG's ability to successfully manage the impact of a cooling Canadian housing market on asset quality and earnings, along with the impact of an eventual rise in interest rates on funding mix and costs. A measured and sustainable diversification of business activities and migration to a more durable, deposit-funded funding profile could also contribute to positive momentum. Deterioration in the Canadian housing market and/or adverse credit performance within HCG's portfolio could result in a downgrade, particularly in the event of a significant decline in operating performance and/or capital erosion. A shift away from HCG's core expertise into higher yielding and potentially higher risk commercial and personal lending products would also be viewed negatively. Moreover, rating pressure could also ensue if HCG's ability to source cost effective funding is compromised. KEY RATING DRIVERS - SUPPORT RATING AND SUPPORT RATING FLOOR HCG has a Support Rating of '5' and Support Rating Floor of 'NF'. Fitch believes that HCG is not systemically important and therefore, the probability of support is unlikely. RATING SENSITIVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR Fitch does not anticipate changes to HCG's Support Ratings or Support Rating Floors given Fitch's view that HCG will remain a non-systemically important institution. Fitch takes the following rating actions: Home Capital Group, Inc. --Long-term IDR downgraded to 'BBB-' from 'BBB'; --Senior Debt downgraded to 'BBB-' from 'BBB'; --Viability Rating downgraded to 'bbb-' from 'bbb'; --Short-term IDR downgraded to 'F3' from 'F2'; --Support affirmed at '5'; --Support Floor affirmed at 'NF'. Home Trust Company --Long-term IDR downgraded to 'BBB-' from 'BBB'; --Viability Rating downgraded to 'bbb-' from 'bbb'; --Short-term IDR downgraded to 'F3' from 'F2'; --Support affirmed at '5'; --Support Floor affirmed at 'NF'. The Rating Outlook has been revised to Stable from Negative. Primary Analyst Ryan Doyle Director +1-212-908-0771 Fitch Ratings, Inc. One State Street Plaza New York, NY 10004 Secondary Analyst Justin Fuller, CFA Senior Director +1-312-368-2057 Committee Chairperson Nathan Flanders Managing Director +1-212-908-0771 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. Additional information is available at 'www.fitchratings.com'. Applicable Criteria and Related Research: --'Canadian Banks: 2013: Another Solid Year, But Consumer Risks Lurk' (Feb. 5, 2014); --'2014 Outlook: Canadian Banks' (Nov. 25, 2013); --'Global Financial Institutions Rating Criteria' (Jan. 31 2014); --'Rating FI Subsidiaries and Holding Companies' (Jan. 31 2014). Applicable Criteria and Related Research: Canadian Banks: 2013: Another Solid Year, But Consumer Risks Lurk here 2014 Outlook: Canadian Banks (Stable Rating Outlook Balanced Against Negative Sector Outlook) here Global Financial Institutions Rating Criteria here Rating FI Subsidiaries and Holding Companies here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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