Well-meaning regulators, from time to time, lose perspective on the very industry they are assigned to oversee.

There is no better example than in the case of Home Capital Group (HCG.TO) (HCGWX), Canada’s largest non-bank mortgage lender. On April 20^th The Ontario Securities Commission (OSC) accused HCG of making misleading statements to investors about its mortgage underwriting. At the heart of their accusations is the use of a handful of mortgage brokers who, it is alleged, have been providing inaccurate information regarding borrowers. This accusation leads to a precipitous withdrawal of deposits used to fund mortgage lending in tandem with a precipitous fall of more than 70 % in the company’s stock price within the space of less than 2 weeks.

The Canadian mortgage market is 75 % dominated by the Big Six chartered banks (Figure 1). Non-bank lenders, such as HCG service borrowers who have found it difficult to secure loans from the Canadian chartered banks. But that does not mean that they are unworthy borrowers. The company offers home loans predominantly to immigrants, self-employed people and others who have non-traditional incomes that make it harder for them to obtain loans from the big banks. American readers should not equate HCG as a subprime lender of the type that brought down U.S. banks in 2008. The Canadian mortgage market is completely different and operates with stricter regulations. The Canadian housing and mortgage market was totally unscathed during the U.S. housing meltdown.

Figure 1 Mortgages Held by Canadian Financial Institutions

In 2015 an HCG investigation resulted in suspending some 50 brokers out of a stable of more than 4000 brokers who work with the company at any given time. However, the company continues to operate under this cloud. Following the OSC’s accusation, the retail depositors have withdrawn more than 90 per cent of their funds from Home Capital’s high-interest savings accounts. In a succession, HCG had arranged a lending facility of C$ 2 billion from an institutional investor. The facility is very onerous regarding fees and other charges, resulting in HCG effectively paying as high as22 % for this lifeline. Not unexpectedly, the share price plunged more than 60 % on this announcement. In effect, the company was forced to destroy the income statement in order to preserve its asset base--- a very high price to pay, but the threat was existential.

Initially, the mortgage lenders, including the Big Six banks were weighed down by developments that hit HCG ( Figure 2)

Figure 2  Impact on Mortgage Lenders

The banks are not likely to buy any of the HCG’s assets since they do not fit their lending standards. However, rival lending institutions have already stepped in and purchased about C$1.5 billion and more assets are likely to be shed to reduce the line of credit and stabilize the company. While retail investors take flight, some large asset managers, such as CIBC Asset Management and Turtle Creek Asset Management have taken large equity positions at these rock bottom prices.

What is most disturbing about the OSC’s actions is that it forced a solid company into an existential crisis. HCG’s mortgage portfolio was not under stress. Its credit losses were in line with the industry’s performance and did not represent any threat to its bottom line. Hence, the widespread interest by venture funds in the United States and Canada in picking up segments of the loan book. The company has issued a “going concern” caution to investors and its future continues to remain uncertain.

Unlike many U.S. mortgage lenders, Canadian mortgage lenders have recourse personally to the borrower. Consequently, Canadians have a strong record of paying down mortgages. Thus, the HCG case should not send a chill through the industry, yet it has raised real concerns in the minds of foreign investors. These concerns are not valid. The actions of the OSC have introduced a considerable unwarranted degree of uncertainty into the domestic mortgage market. Forcing a company to shed good performing assets because of a compliance issue is no way for a regulator to carry out its responsibilities.