This alternative lending company offers investors a huge margin of safety

The Canadian real estate market has been one of the hottest topics in the country in recent years. With the rapid growth in house prices and household debt at record levels, it is natural to wonder what the future of the real estate industry is.

For mortgage companies, business has been tough during this time as more stringent regulations were put in place to protect taxpayers. One company that has really been hit by the negative industry consensus is Home Capital Group (TSX: HCG).

Home Capital is a specialty finance company primarily engaged in mortgage lending. The company generally deals with borrowers who do not meet normal banking requirements. It offers traditional mortgages and consumer loans as well as securitization of insured mortgages and home equity lines of credit.

Past numbers

Home Capital’s troubles all started when it had a drop in loan origination in 2015. This was due to the company severing ties with brokers who forged documents. Eventually, the Ontario Securities Commission said it was investigating. The investigation, coupled with a high short-term interest in the stock, decimated the stock price.

The problems only worsened as investors and depositors lost confidence, which led to a run on the bank, which ultimately forced the company into a liquidity crunch.

As the company began to recover and began to attract new depositors, management took care to transform its new deposits into products that are not easily redeemable. In the past, a large portion of the company’s deposits were sight deposits. This time around, the company issued many more fixed rate GICs.

The increase in term deposits should allow Home Capital to better commit to its loan arrangements, as it has a better idea of ​​the duration available on most of its deposits.

More recently, Home Capital has struggled to bounce back fully as mortgage regulation in Canada has become more stringent. This has an impact on Home Capital, as as an alternative finance company it primarily deals with higher risk sub-prime borrowers.

Although the stock has rallied slightly over the past two years and the company has started to rally, the stock is still trading well below all-time highs.

Company operations

When looking at Home Capital’s loan portfolio, the first thing to notice is the high quality nature of its portfolio. NPLs have increased slightly in recent times, but still represent less than half of 1% of total loans. In addition, net write-offs in the first quarter were only 0.02% of loans on an annualized basis.

While the average Home Capital client is typically a subprime borrower, the portfolio’s loan-to-value (LTV) ratios appear impressive. The weighted average residential mortgage LTV was 59% in the first quarter, which means that on average Home Capital borrowers own 41% of their homes.

This suggests that its mortgage portfolio is more stable than the market believes, as borrowers with higher equity are much less likely to default on their mortgages.

At the end of the line

With a market cap of just $ 1.1 billion, the company seems well undervalued, even for a company in an unloved industry like real estate. Currently, the price-to-book ratio stands at just 0.68. Having such a low price-to-book ratio can be a great opportunity for investors, as it provides the opportunity to invest in the stock at a favorable price.

In addition, in the event of a collapse in the real estate market in Canada, the rebate offers investors a large margin of safety. The stock cannot go down much more than it has already.

Stay hungry. Stay stupid.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We are straight! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer, so we post sometimes articles that may not conform to recommendations, rankings or other content.

Foolish contributor Daniel Da Costa has no position in any of the stocks mentioned.

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