Home Capital Group Initiating Coverage (HCG-T)

Home Capital Group (HCG-T)

Nicholas Di Giorgio

Andrew Macdonald

Zeeshan Maqsood

1

Company Profile

Company Description

Home Capital Group Inc. is a public company, traded on

the Toronto Stock Exchange (HCG). It’s principal

subsidiary is the Home Trust Company, which is federally

regulated.

They provide deposit services, mortgage lending,

securitization of insured residential first mortgages,

payment card services, and retail lending

Licensed to conduct business across Canada, Home

Trust has branch offices in Ontario, Alberta, British

Columbia, Nova Scotia, Quebec and Manitoba.

Focuses on providing fixed rate residential first

mortgages to borrowers that fail to meet the big banks’

lending requirements

Residential borrowers primarily consist of self-employed

individuals, individuals with a short or limited credit

history and individuals with some impairment in their

credit history

Recent News

Nov 7th, 2012 – 2012/3Q Results: HCG reports record

quarter and dividend increase. Diluted EPS was up

18.7% YoY, with ROE continues strong at 25.6%. Tier 1

Capital ratio stands at 16.97%.

Sep 12th, 2012 – HCG files Normal Course Issuer Bid, to

buy back shares representing approximately 10% of its

float

Aug 1st, 2012 – 2012/2Q Results: HCG reports strong

performance for 2nd Q, with EPS increasing 14.5% YoY,

and with a strong ROE of 25.1%. HCG reaffirms fiscal

2012 guidance, expects net income to grow at 13-18%

May 3rd 2012: HCG announced a 10% increase in its

quarterly dividend, and is the 14th increase in the last 8

years reflecting Home Capital’s strong growth, profitability

and commitment to enhancing long-term shareholder

value.

April 2nd 2012: S&P has affirmed its BBB+ rating to Home

Trust Company. Home Trust is the only trust company in

Canada, not a subsidiary of a major financial institution,

to maintain an investment grade from S&P.

Management and Board

Gerald M. Soloway – CEO since 1987

Martin K. Reid – President of the Corporation

Brian R. Mosko, COO, Employee since 1989

Robert J. Blowes C.A., CPA – CFO and EVP

2

Market Summary

Market Summary Share Trading Performance – 10/3/2011 – 11/7/2012

(in C$ millions except per share data)

Share Price (today) $50.92

Dividend Yield 1.7%

52 Week High $54.99

52 Week Low $42.00

Shares Outstanding (mm) 34.7

Equity Market Value $1,767

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

$40.00

$42.00

$44.00

$46.00

$48.00

$50.00

$52.00

$54.00

$56.00

10/3/2011 2/3/2012 6/3/2012 10/3/2012

Volume HCG

FY end Feb 15 2013

Forecast & Multiples 2011A 2012E(1) 2013E(1) 2014E(1)

Revenue $369 $428 $488 $571

Revenue growth 15.4% 14.1% 17.0%

EPS 5.46 6.33 7.17 8.38

EPS Growth 15.9% 13.3% 16.9%

Price / EPS 9.3x 8.0x 7.1x 6.1x

Metrics

Tier 1 Capital Ratio 17.1%

Net interest margin (2) 2.06% 2.09% 2.21%

Efficiency Ratio (2) 27.90% 27.70% 26.50%

ROE 2) 27.40% 25.40% 23.40%

(1) Estimates as per analyst consensus

(2) Estimates as per Industrial Alliance Analyst

Residential Mortgages

CMHC Mortgages

Non-Residential Mortgages

Consumer Lending

Business Segments

Stock Trading Analysis

3

$40.00

$42.00

$44.00

$46.00

$48.00

$50.00

$52.00

$54.00

$56.00

10/3/2011 12/3/2011 2/3/2012 4/3/2012 6/3/2012 8/3/2012 10/3/2012

Home Capital Group Inc.

announces an Equity Buyback

Q2 Earnings, Strong quarter with

EPS YoY 14.5% Growth,

ROE 25.1%

Reaffirms strong guidance

2012/Q1 Earnings

Dividend is increased by 10%

EPS guidance in mid-teens

2011/Q4 Earnings

Adj. EPS $5.55

EPS up 22.69% for FY 2011

Approves quarterly dividend

ROE 27.4%

S&P Reaffirms HCG’s trust

BBB+ rating

2011/Q3 Earnings

EPS $1.40

ROE 27.0%

Table of Content

I. Investment Thesis

II. Industry Overview

III. Macroeconomic Outlook

IV. Company Overview

V. Risks

VI. Financials

VII. Valuation

VIII.Recommendation

IX. Appendix

4

Section I

Investment Thesis

6

Investment Thesis

Initiating coverage on Home Capital Group (Buy at $50/share with a 2013 end of year price target of $67)

Major Trend #1: Market Share Shifts from Big-6 to Alt-A Lenders - The recent changes in mortgages

insurance rules and OSFI’s Guideline B-20 has created a prime opportunity for alternative lenders as big

banks have tightened policies, scaled back loans to self employed and as a result there will be more

volume and higher quality borrowers for Alt-A lenders.

Major Trend #2: Sentiment risk related to housing market is baked in stock price. Trading at just 7.9x

2012E P/E, and growing at 15% EPS per year, a lot of the negative expectations for a Canadian housing

crash is baked in. Since 2004, HCG has traded at an average of 14.1x TTM earnings and 3.6x BVPS vs.

8.5x and 2.0x, respectively today. That equates to a ~40-45% discount to its historic levels.

Major Trend #3: Due diligence in underwriting, relatively high credit quality of borrower. Total

condominiums that were underwritten are less than 3% of their loans for 2011; thus staying out of the high

risk markets. In addition, the company does a room by room walk through, ongoing risk monitoring, top Tier

1 Capital Ratios of all banks in Canada, low non performing loans, and low arrears. Their borrowers are not

as risky as the market perceives them to be.

Macro Trend #1: Cooling off of housing market. Although there is oversupply of houses, it is

predominantly in the condominium markets in metropolitan cities. Existing resale prices are expected to

stabilize, and existing home sales are down. We wonder if YoY sales decline is a predictor for YoY price

decline to come in 2013.

Catalysts: Stabilization of housing sales & prices & consistent performance (in terms of revenue and risk)

Risks: Housing bubble, interest rate hikes, unemployment picking up

Section II

Industry Overview

8

Market Size and Growth

Canadian Mortgage Market

Subprime (~$27.5B) – Terrible credit score, NINJA

loans, tarnished credit history

Prime (~$896.5B) – Good credit history, business is

mostly reserved to the Big-6

Alt-a (~$176B) – Near prime, borrowers with little credit

history, immigrants, self-employed, not qualifying for

insurance from CMHC

Credit Score Criteria

BEACON Score: An individual’s credit rating is

measured by a Beacon score in Canada which tracks

a variety of criteria to deliver a risk profile; effectively

and quickly segmenting a large portion of borrowers to

provide a preliminary assessment of their ability to pay

interest and repay principal

The BEACON Score gives 50% weighting to credit history. For immigrants with little credit history, this makes getting

a loan from the big-6 very difficult.

Types of Credit, 10%

New Credit, 10%

Length of Credit History,

15%

Amounts Owed, 30%

Payment History, 35%

Criteria Evaluation

Prime, 900

Alt-A, 198

Subprime, 22

Market Size (2011)

9


Distribution of Beacon Groups

Home Capital Group’s non-performing loans make up only 0.28% of its loan portfolio. Huge disparity between what’s

expected of alt-a, and what is actually observed.

4% 4% 6%

11%

19%

27% 24%

5%

000-549 550-599 600-649 650-699 700-749 750-799 800-850 850+

% o

f To

tal

Ca

na

dia

n

Cre

dit

78%

60%

39%

23% 12%

5% 2% 1%

000-549 550-599 600-649 650-699 700-749 750-799 800-850 850+

Pro

ba

bil

ity o

f D

eli

nq

ue

nc

y

Alt-A Prime

Alt-A Prime Subprime

Subprime

10


Canadian Housing Market

Canadian Residential mortgage market at about $1.1

trillion

The market has grown at a 9% CAGR over the last ten

years

Housing starts slowed in 2012 – the forecasted growth

rate of the residential mortgage credit in 2012 and 2013

respectively is 8.5% and 8.2% (CAAMP).

Alt-A Market Size and Outlook

Non-prime mortgages represent between 10-20% of

total market

Subprime alone makes up 2-3% of total mortgage

market

Alt-A is somewhere around 7-18% of total market

($77-198B)

HCG’s total addressable market is about 60% of the

total non-prime market ($66-132B)

The non-prime mortgage market is growing faster than the entire market is. Tighter regulations are forcing more and

more prime borrowers into the Alt-A market

Total Mortgage Credit Outstanding 1100.0

Big-6 Market Share 74%

Nominal Big-6 Mortgage Credit 814.0

Mortgage Approval at Big-6 80%

Total Mortgage Applications 1017.5

Applications Rejected (Proxy for non-prime) 203.5

Subprime (2.5% of total mortgage credit) 27.5

Alt-A (est. 16% of total mortgage credit) 176.0

Prime (est. 81.5% of total mortgage credit) 896.5

All numbers in billions

11

Drivers of Alt-A

Immigration

Canada, highest inflow of permanent residents

among OECD countries. The annual rate of growth is

about 0.8% of its population

Recent Immigrants earn less employment income for

each dollar earned by Canadian-born men.

1980 - 85 cents

2000 - 67 cents

2005 - 65 cents.

Average immigrants accepted 240k-260k over the

past 6 years. This number is expected to be steady in

2013

However, only about 65k are “economic” immigrants,

including skilled workers – that are immediately

immersed into the job market. There is some slight

favoritism to skilled workers going forward.

The Federal Skilled Worker (FSW) Program ensures

that immigrants with skills and proficiency in one of the

official languages are prioritized

New Permanent Residents Admitted in 2011 and 2012

Levels Plan

Drivers of Alt-A

12

Annual growth rate per year in # of self-employed of:

Last 5 years: 16,530

Last 10 years: 41,347

Since 1983: 42,891

Self-employment outlook

Self-employed individuals will deduct their expenses and

taxable income will not appear very high. Disposable

income is actually high though.

Irregularity of incoming cash flows mean some are

rejected by prime lenders, despite an acceptable credit

score.

Section III

Macroeconomic Outlook

Bank Of Canada - Housing Outlook

14

Source: Bank of Canada Financial System Review June 2012

Regulators are concerned about the housing market in

Canada, but have learned from the 2008 sub-prime crisis.

A soft landing is more likely scenario with stabilizing

measures coming into effect.

Supply of multiple-unit dwellings under construction is

significantly above its historical average

House prices in Canada are still high relative to

disposable income

“Rates will not remain at their current levels forever.

The impact of eventual increases is likely to be greater

than in previous cycles, given the higher stock of debt

owed by Canadian households”- Mark Carney June 2011

Housing in Canada Report

Total household credit grew by about 6% from May to

October 2011 and by about 4% from November 2011 to

April 2012. The slowdown is evident in both mortgage

and non-mortgage credit.

“Housing activity is expected to decline from

historically high levels, while the household debt

burden is expected to rise further before stabilizing by the

end of the projection horizon.” BoC Oct. 2012

Bank of Canada Outlook

Bank of Canada - Interest Rate Outlook

15

Bank of Canada has been conducting a Housing

Vulnerability Assessment since 2008

Expectations for an increase in interest rates in late 2013

to early 2014

Sensitivity of interest rate increases, unemployment, and

debt to income growth

Recent data suggest there has been a slowing in growth

of loans in both residential mortgages and consumer

loans.

If there was a 3.25% change in interest rates by 2015,

the number of households with a DSR over 40% would

rise from 11.5 to 20% by 2016. Making the sector more

vulnerable.

2x double in arrears

With 10% unemployment

CMHC Housing Outlook

16

• Sales of existing homes have moderated so far. Moving

forward they are expected to remain stable.

• Resale prices are expected to remain balanced

conditions for 2012 and 2013

• Multi-unit starts have been strengthening housing

starts(Increased 16.6%), while single unit starts have

stabilized.

• Continued short-term mortgage rates will support

housing demand in 2012-2013

1

1.5

2

2.5

3

3.5

4

4.5

5

1995 1997 1999 2001 2003 2005 2007 2009 2011

Annual Average Vacancy Rates (Rentals)

100000

150000

200000

250000

1979 1983 1987 1991 1995 1999 2003 2007 2011

Historical Housing Starts

Worst Case Best Case

Source: StatsCan, CREA, CMHC

Multi-unit construction starts have been increasing supply have been driving supply,

but stabilizing prices and starts will contribute to a slow down in the real estate market.

Annual Average Vacancy Rates expected to stay stable

but with extra supply, it may go up

US vs. Canada

17

Canadian House Prices have surpassed 2008 levels, and have increased over 50% in

10 years. US prices in comparison increased nearly 100% in 6 years.

The Canadian mortgage market originates shorter term mortgages (5 year fixed vs. 30 years)

The U.S. had NINJA loans, loose underwriting standards and a very liquid securitization market

There was a lot of speculative home buying (22% of houses were purchased for investment purposes as opposed to

2.5% for Canada)

90% of U.S sub-prime mortgages issued in 2006 were ARMs with low teaser rates

Toronto Housing Factors

18

Apartments and condominium supply

have been increasing at an alarming rate,

while demand factors have been stable.

HCG has been aware of this trend and

have limited exposure to this market.

Source: Statscan

Ontario Housing Supply Factors

19

Ontario may be more representative for

HCG since they aim to concentrate their

loans outside of Toronto multi-unit

market. Trends over supply are

significant but less pronounced.

Canadian City Housing Price Index

20

Source: Teranet

Home resale prices in cities have increased much faster than surrounding areas.

Western cities have increased much faster than Toronto and Montreal.

Provincial House Price Index

21

Source: Statscan

House prices for provinces have increased but not as fast as the cities, which

is important for HCG which doesn’t concentrate properties in cities. Western

provinces have experienced much faster growth.

OSFI / IFRS – Legislative Changes

22

• Lowered Amortization 30 years to 25 years

• Decreased Loan to Value Ratio 80%

• Capped Gross Debt Service and Total Debt

Service to 39% and 44% respectively

• No insurance for properties over $1M with

reduced LTV ratio

• Stricter Stated Income disclosure

• Stricter qualifying rates

• IFRS – MBS Accounting Changes

Legislative Changes Effects

• Upgrading properties will be forced

refinanced at a 25 year amortization rate

• Less people will refinance mortgages if they

have a greater than 80% LTV.

• Capped ratios will limit the amount of

mortgage, forcing borrowers to buy less

expensive homes

• Individuals with properties over $1M will not

represent the majority of mortgage holders

effected

• Self-employed individuals must provide

reasonable verification of income.

• Less people will be able to qualify for

mortgages with stricter and higher qualifying

rates to calculate debt service ratios

• Banks and mortgage lenders will need to

have more equity, less leverage and will

decrease returns

Government’s tightening of the mortgage rules reduces buying power of Canadians

is the key driver of increasing the Alt-A Market size

Section IV

Company Overview

24

Portfolio of Mortgage Loans

Highest quality, low volatility of prices

Single Family Homes Alt-A (43.65%) Single Family Homes Insured -MBS (53.9%)

Insured housing by CMHC Condominiums (<2.4%)

Very

Risky

25

Segment Overview - Traditional

Mortgage Lending

Single-family and multi-unit residential lending, and non-

residential lending.

Traditional mortgage portfolio consists of mortgages with

loan to value (LTV) ratios of 80% or less

Residential borrowers primarily consist of self-employed

individuals, individuals with a short or limited credit

history and individuals with some impairment in their

credit history

Home Trust’s main residential offering is fixed rate

mortgages with terms up to five years

Mortgages are mainly sold through independent

mortgage brokers. Deposits are collected mainly through

independent brokers as well.

Core, highly profitable business is non-insured

mortgages. Insured mortgages are growing, however.

Established nationwide branch network:

Toronto

Montreal

Halifax

Winnipeg

Calgary

Vancouver

Mortgage Borrower Segmentation

42.5%

42.5%

15.0%

New entrants

Entrepreneurs

Bankruptcy discharge

Mortgage Loan Segmentation

52.4%

47.6% Insured

Non-insured LTV<70%

26

Competitive Landscape

Competitive Advantages

Superior underwriting experience:

The value of the asset is prioritized over the credit

of the customer.

Individual room walk-through, and independent

appraisals on a rapid sale basis

Average LTV is 69.6%.

Established branches nationwide will facilitate growth

into the rest of Canada

One-stop shop mortgage lender - cross-sell potential

with Visa consumer lending (HELOC), high-interest

savings accounts, GIC’s, water-heater loans

Expertise and experience since 1986 – proven success

over the last 26 years. Successful marketing campaigns

with brokers have helped establish good relationships

with brokers.

Barriers to entry - CDIC licensing requirements. Limited

shelf space with mortgage brokers. The need for

specialized underwriting expertise.

Main competitors

Loans in Billions for Alt-A

1. Equitable Group (467mm) – Very similar to HCG

2. Counsel Corp (Street Capital Financial) (87.2mm) –

Street Capital is mostly a prime lender. Several other

facets of the business not focusing on alt-a mortgage

lending. Street Capital was established in 2008.

3. Canadian Western Bank (2,250mm) – Provides

banking services regionally in western Canada. Personal

and commercial banking, trust services, and wealth

management solutions.

17.256

9.95

0.93

Home Capital Group

Equitable Group

Canadian Western Bank

Home Capital and Equitable are the biggest players.

Home Capital is much better positioned for growth

outside of Ontario given their already established

network nationwide. Their much larger scale means

they are well established within the broker circles.

27

NIM, Efficiency Ratio

Competitive Position Loan Segmentation – Geography

Revenue Segmentation – Operating Segment

HCG is the lowest cost operator with a 28% efficiency ratio. HCG also has the highest NIM.

Canadian Mortgage Housing Corporation

28

Dominion Housing Act (1935) – Joint lending between institutional lenders and the government.

Established monthly interest and principal payments

National Housing Act (1944)– Response to low levels of residential construction prior to and

during WW2

Central Mortgage and Housing Corporation (1945)– First time a Crown Corporation could

make direct loans to home owners or developers. Received money from the Consolidated Revenue

Fund in exchange for debentures that were to repaid through mortgage activity

(1944-1953) 26% of all residential construction took place under the creation of the

CMHC

Wartime Housing Act (1955) Ajax, Ontario was created during the Wartime Housing act to provide

housing for munitions workers and returning veterans. CMHC was responsible for turning Ajax into a

functioning municipality and reimbursing Pickering Township for municipal services administered to

Ajax.

The Bank Act (1954)- Chartered Banks are allowed to engage in lending mortgages under the

National Housing Act.

MBS (1986) CMHC begins to invest in MBS as an alternative to investing in individual mortgages.

MBS ensure a supply of low cost funds for housing financing and try to keep mortgage lending costs

low.

Source: www.canadamortgage.com; CMHC

http://www.canadamortgage.com/

Canadian Mortgage Securitization Structure Made Easy

29

Segment Overview Securitized Mortgages

30

• Securitized mortgage currently represents the bulk of revenues and

assets for HCG

• The net interest margins are half that of non-securitized traditional

mortgages.

• New IFRS accounting rules put MBS on financial institutions

balance sheets leading to more capital required and lower returns

• Spreads on securitized assets are lower than they were in 2008 and

the main component of this is the low interest rate environment.

• NIM on securitized assets is about 1.23% which is half of what non-

securitized traditional loans produced. This asset base has a slower

growth rate increasing 1.5% from 2011-2010

31

Segment Overview - Other

Consumer Lending

Consumer lending includes Visa, retail lending and

payment card services

Homeowners use their home equity as collateral to obtain

credit

Fees and other income are also collected from

administration of mortgages and Visa accounts

2012 Outlook:

The Company anticipates continued measured growth

in the water heater line of business and is currently

exploring this channel for other growth opportunities.

Equityline Visa is renewing their focus on growing this

business after a cautionary pause over the past 2

quarters.

Fees and other income are expected to grow with the

size of the portfolio.

Net Income Segmentation – FY 2011

Personal & Credit Card NIM and Assets

Management

32

• One of the founding member of HCG and CEO and President since 1987

• Spearheaded the strategy to lend to self-employed and people with a limited credit history

• Prior to HCG practiced real estate, mortgage and commercial law in Toronto

Gerald Soloway, CEO (5.6% Ownership)

• Strong insider ownership of 8.7% float

• Commitment to repurchase shares 350,000 shares for 2010 and 2011

• Strong emphasis on Risk Management and Corporate

• Strong institutional support

Alignment of Interests

Martin Reid, President

• Over 20 years experience in financial services industry

• Prior to HGC worked in market risk for Deutsche Bank Canada and Dundee

• Accredit Mortgage professional,

Section V

Risks

34

Risk Management

Management bets correctly on type of mortgages1

Management bets correctly on the right regions1

High risk lending such as condominiums represented 11.2% of mortgage

advances in 2010, now down to 2.7% of loans issued in 2011

$766,483

$137,005

2010 2011

Multi-unit residential mortgages

$2,853,385

$3,514,430

2010 2011

Traditional Single-family residential mortgages

$542,518

$234,229

2010 2011

British Columbia Mortgage Advances

$5,278,029

$4,400,136

2010 2011

Ontario Mortgage Advances

1 Amounts denominated are in $000s

35

Risk Management

Single House vs. Condos

Interest Rate Risk




The single family home market is another thing. There’s

not a lot of new supply coming in

For the single-family home market, “They’re not making

more land,” as realtors love to say.

Sales of condos has slipped 14% YoY in Toronto with

prices down 2% YoY, while single family detached houses

prices are up 17% in Toronto

Increase in Interest Rates

100 basis point shift 2010 2011

Impact on Net Interest Income 10597 8142

Impact on NPV of shareholders' equity 19871 4175

Decrease in Interest Rates

100 basis point shift 2010 2011

Impact on Net Interest Income -10597 -8142

Impact on NPV of shareholders' equity -19871 -4175

36

Risk Management

Allowances for Loans

Net Write Offs


•HCG is growing the risk management and credit risk departments with important additions to their team

•HCG has a stronger capital ratios., which will serve as a buffer to declining home prices.

37

Risk Management

GAAP -> IFRS Changes




38

Capital Management

Tier 1 Capital Ratio Basel III

Home has the highest capital ratios in Canada compared to

other publicly reporting deposit taking financial insitutions


Liquidity Coverage Ratio (LCR). The LCR establishes a

common measure of liquidity risk and requires institutions

to maintain sufficient liquid assets to cover a minimum of

30 days of cash flow requirements in a stress situation.

As at Q3 2012 the Company had sufficient liquid assets

to meet the minimum LCR.

Conservation Buffer and Counter-cyclical Buffer. A capital

conservation buffer of common equity equal to 2.5% of

risk-weighted assets (RWA) will be phased in between

2016 and 2019 and will ultimately require a minimum

tangible common equity ratio of 7.0% and a Total capital

ratio of 10.5%.

As at December 31, 2011 Home Trust had sufficient

capital resources to adopt the conservation buffer. As at

Q3 2012 Home Trust had sufficient capital resources to

adopt the counter-cyclical buffer at the top of the range.

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

2008 2009 2010 2011 2012

Tier 1 Capital Basel III 7%

Section VI

Financials

40

Historical Financial Summary

Revenue

ROA

ROE

EPS

(In C$ millions) (%)

(%) (In C$)

5-Year EPS CAGR: 22%

41


Superior Tier 1 Capital Ratio

Tech Bubble (Q2/2001 – Q4/2001)

Loan to Value of HCG’s residential mortgage portfolio

Credit Crisis (Q1/2008-Q2/2009)

6

8

10

12

14

16

18

CIBC BMO TD BNS RBC HCG

Tier 1 Capital (2011)

50

55

60

65

70

75

2007 2008 2009 2010 2011

42


Net Income

Consistent Loan Growth

(In C$ millions)

0.1 1.2 3.0 6.1 8.1 10.5 14.9 20.6 29.5 44.6

60.9 67.8

90.2 108.7

144.5 154.8

190.1 204.5

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Q2

Net Income

11.44 11.65 12.02 12.68 12.7

11.1

12.9

16.4

18.1 17.3 17.1

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Tier 1 Capital Ratio %

Forecasted Income Statement

43

Income Statement (Consolidated) 2010 2011 2012 2013 2014 2015 2016 2017

Interest from Loans 353,779 401,671 494,258 604,877 715,948 843,557 975,856 1,119,090 Dividends from Securities and Other Interest 28,010 23,500 23,546 24,754 25,962 27,169 28,377 29,585 Interest Income 381,789 425,171 517,804 629,631 741,910 870,726 1,004,233 1,148,675

Interest on Deposits 188,370 191,745 233,691 267,124 297,140 335,018 372,219 417,403 Interest on Senior Debt 5,293 5,293 5,361 5,387 5,446 5,489 5,565 Interest Expense 188,370 197,038 238,984 272,485 302,527 340,465 377,708 422,969

Net Interest Income Non-Securitized Assets 193,419 228,133 278,820 357,146 439,383 530,261 626,525 725,706

Interest from Securitized Loans and Assets 251,292 330,491 308,900 315,078 321,379 332,490 343,916 355,667 Interest on Securitization Liabilities 180,681 224,719 199,859 203,856 207,933 214,440 219,687 224,081 Net Interest Income Securitized Loans & Assets 70,611 105,772 109,041 111,221 113,446 118,049 124,229 131,585

Total Net Interest Income 264,030 333,905 387,861 468,368 552,829 648,311 750,754 857,291

Net Interest Margin (Avg) 2.24% 2.17% 2.23% 2.42% 2.59% 2.75% 2.92% 3.05% Net Interest Margin (EOY) 2.07% 2.06%

Provision for Loan Losses 9431 7,519 10,445 15,505 21,351 23,543 25,753 28,096 Net Interest Income After Provisions 254,599 326,386 377,416 452,863 531,477 624,767 725,001 829,195

Fees and other income 30,690 37,997 45,596 52,436 58,728 64,601 69,769 73,258 Gain on sale of loan portfolio 3,917 - - - - - - - Realized net gains and unrealized losses on securities 9,740 4,088 4,211 4,337 4,467 4,601 4,739 4,881 Net realized and unrealized (loss) gain on derivatives 9,821 (7,203) - - - - - - Non-Interest Income 54,168 34,882 49,807 56,773 63,195 69,202 74,508 78,139 Total revenue, net of interest expense 318,198 368,787 437,668 525,141 616,024 717,513 825,262 935,430

Non-interest expense Salaries, Benefits and Premises 53,633 60,299 71,777 86,648 102,876 120,183 139,057 157,152 Other 41,843 44,703 52,958 64,067 75,771 88,613 101,714 115,409 Non-Interest Expenses 95,476 105,002 124,735 150,715 178,647 208,796 240,770 272,561

Efficiency Ratio 30.01% 28.47% 28.50% 28.70% 29.00% 29.10% 29.18% 29.14%

Income before Taxes (EBT) 213,291 256,266 302,488 358,920 416,026 485,173 558,739 634,773 Income Taxes 58539 66233 77,437 91,884 106,503 124,204 143,037 162,502

Net Income 154,752 190,033 225,051 267,036 309,523 360,969 415,702 472,271

Shares Outstanding 34,646 34,625 34,279 33,936 33,597 33,261 32,928 32,599 Diluted Shares Oustanding 34,776 34,787 34,488 34,143 33,802 33,464 33,129 32,798

EPS $ 4.47 $ 5.49 $ 6.57 $ 7.87 $ 9.21 $ 10.85 $ 12.62 $ 14.49 Diluted EPS $ 4.45 $ 5.46 $ 6.53 $ 7.82 $ 9.16 $ 10.79 $ 12.55 $ 14.40 EPS GROWTH 19.45% 19.85% 17.08% 17.80% 16.33% 14.76%

Section VII

Valuation

Market Performance

45

Home Capital Group has significantly outperformed the Canadian financials average returns

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

200.00

1/2/2007 7/2/2007 1/2/2008 7/2/2008 1/2/2009 7/2/2009 1/2/2010 7/2/2010 1/2/2011 7/2/2011 1/2/2012 7/2/2012

Home Capital Group S&P/TSX Financials Index

HCG 1.55

S&P/TSX Financials 0.42

Valuation - DDM

Under the dividend discount model, assuming management pays out around a 50% dividend payout ratio and potentially

instead of buybacking back stock it could pay out even more dividends pushing the ratio to above 60%.

At a 50% dividend payout ratio, 11.0% discount rate and 3% terminal growth, we arrive at a target price of $64.35 or

approximately a 28% discount to our buy price at $50 a share. Increasing the payout ratio to 60% in 2017 gives us a

price target of $76 per share.

We think a 3% terminal growth rate is fair, given that it is a function of a) housing price increases (nominal), b) productivity

increases, c) continued market share gains

Given that the stock today trades at around $50, the stock currently implies a 13.5% discount rate (or about a 7.4x

earnings multiple), which means that investors are being risk averse.

We think the shares are undervalued, and even if the multiple does not expand, the EPS is growing at a 15%+

CAGR (much greater than the Big-6) for the next 3 years implying we believe HCG will be one of the best

performing financials in the Canadian market.

Given a 1.05 beta over the past 10 years, we calculate a cost of equity of 1.05*5.5% + 2% = 7.775%. We

have added a 5% discount for conservatism. (The terminal discount rate used is 11%)

Dividend Discount Model: Sensitivity

Discount Rate (Time Periods 1-5)

Gro

wth

in t

erm

inal

ye

ar

$ 61.68 8.00% 9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%

2.00% $ 82.39 $ 72.07 $ 64.25 $ 58.09 $ 53.10 $ 48.96 $ 45.47 $ 42.47

2.50% $ 89.04 $ 76.94 $ 67.97 $ 61.04 $ 55.49 $ 50.95 $ 47.15 $ 43.91

3.00% $ 97.01 $ 82.62 $ 72.23 $ 64.35 $ 58.15 $ 53.14 $ 48.98 $ 45.47

3.50% $ 106.77 $ 89.33 $ 77.14 $ 68.11 $ 61.13 $ 55.55 $ 50.98 $ 47.16

4.00% $ 118.96 $ 97.38 $ 82.87 $ 72.41 $ 64.48 $ 58.24 $ 53.19 $ 49.01

4.50% $ 134.63 $ 107.23 $ 89.65 $ 77.36 $ 68.27 $ 61.24 $ 55.63 $ 51.03

5.00% $ 155.53 $ 119.53 $ 97.77 $ 83.15 $ 72.60 $ 64.61 $ 58.34 $ 53.26

5.50% $ 184.78 $ 135.35 $ 107.71 $ 89.98 $ 77.60 $ 68.44 $ 61.36 $ 55.72

6.00% $ 228.67 $ 156.44 $ 120.12 $ 98.18 $ 83.44 $ 72.81 $ 64.77 $ 58.45

Valuation - Historical

Trading at a discount to its historical P/E

Although Canadian banks valuations have come down due to higher regulatory capital requirements, HCG benefits

from this indirectly since they are getting near prime borrowers and banks are scaling back from uninsured mortgages

We believe that HCG exhibits a better earnings growth and ROE profile, at improving credit quality versus the Big-6,

while also being a very liquid security.

We do not believe that the market attributes any value to growth catalysts like MBS strips

0

5

10

15

20

25

30

11/15/2002 11/15/2003 11/15/2004 11/15/2005 11/15/2006 11/15/2007 11/15/2008 11/15/2009 11/15/2010 11/15/2011

10-Y Average 13.0x

Trading at 8.3x

Valuation - Comps

HCG trades at a discount versus the Big-6

Comparables Analysis Price Market Cap($Ms) P/E Current Current ROE Dividend

11-Nov-12 TTM 2012 2013 BVPS P/B Yield

Canadian Mortgage Specialty Lender

HOME CAPITAL GROUP INC $ 52.20 1810 8.47x 8.18x 7.21x $ 25.05 2.08x 26.02% 1.99%

COUNSEL CORPORATION $ 0.95 81 2.38x 6.95x 5.18x $ 0.99 0.96x 51.03% 0.00%

MCAN MORTGAGE CORP $ 14.00 262 12.66x 10.94x 10.53x $ 9.06 1.55x 15.20% 8.00%

FIRM CAPITAL MORTGAGE $ 13.60 235 13.29x 13.95x 13.47x $ 10.15 1.34x 10.28% 6.88%

EQUITABLE GROUP $ 30.90 467 6.96x 6.43x 5.82x $ 27.46 1.13x 17.26% 1.81%

EQUITY FINANCIAL HOLDINGS $ 8.00 73 66.67x 34.78x 11.03x $ 5.66 1.41x 1.92% 0.00%

FIRST NATIONAL FINANCIAL $ 16.73 1003 11.08x 9.97x 8.94x $ 3.54 4.73x 35.41% 7.77%

Mean 562 17.36x 13.03x 8.88x 1.89x 22.45% 3.78%

Median 262 11.08x 9.97x 8.94x 1.41x 17.26% 1.99%

Canadian Banks

ROYAL BANK OF CANADA $ 55.85 80687 11.66x 11.28x 10.63x $ 26.56 2.10x 19.21% 4.30%

TORONTO-DOMINION BANK $ 80.06 73206 11.70x 10.90x 10.25x $ 47.26 1.69x 14.85% 3.85%

BANK OF NOVA SCOTIA $ 53.80 63472 10.37x 11.24x 10.54x $ 28.29 1.90x 19.38% 4.24%

BANK OF MONTREAL $ 58.57 38101 9.86x 10.35x 9.90x $ 39.43 1.49x 15.85% 4.92%

CIBC $ 78.35 31767 10.12x 9.84x 9.52x $ 36.57 2.14x 22.58% 4.80%

NATIONAL BANK OF CANADA $ 76.39 12367 8.33x 9.79x 9.40x $ 41.02 1.86x 22.46% 4.14%

CANADIAN WESTERN BANK $ 28.56 2248 12.75x 12.38x 11.29x $ 15.56 1.84x 14.73% 2.24%

LAURENTIAN BANK OF CANADA $ 43.84 1233 9.74x 8.68x 7.94x $ 43.30 1.01x 10.70% 4.29%

Mean 31770 10.41x 10.45x 9.83x 1.70x 17.22% 4.07%

Median 31767 10.12x 10.35x 9.90x 1.84x 15.85% 4.24%

HOME CAPITAL GROUP INC $ 52.20 1810 8.47x 8.18x 7.21x $ 25.05 2.08x 26.02% 1.99%

Valuation - Versus Peers

HCG trades at a 35% discount versus the Big-6

We think this is unjustified due to HCG’s superior growth

profile, lower PCLs, higher Tier 1 Capital Ratio and higher

ROE.

0

1

2

3

4

5

6

7

8

9

11/15/2002 11/15/2004 11/15/2006 11/15/2008 11/15/2010

10-Y Average 3.74x

Trading at 2.06x

Trading at a discount to its historical price to book

Given that the company has a very high ROE ratio, with

high growth rates, we think the company would be more

fairly valued at a 2.5-3.0x book value or $62.5-$75.0

50

Performance Drivers

Unemployment rate to be lower than 7% by 2014

As the Canadian economy improves, the % of

mortgage in arrears should also decrease


5

6

7

8

9

10

11

12

13

14

Mar-76 Mar-81 Mar-86 Mar-91 Mar-96 Mar-01 Mar-06 Mar-11 Mar-16

Unemployment Rate

Section VIII

Recommendation

52

Recommendation

Conclusion

Home Capital Group is a buy as it is trading at an attractive valuation, there is an expanding market size due to the Big-6

tightening their lending standards, attractive spreads, excessive negative sentiment risk related to housing market while

HCG has a high due dilligence in underwriting.

Flaherty’s rule changes has benefited Home Capital. For example, banks immigrant mortgage acceptance criteria

increased from 6-12 months to 2 years, so this incremental underwriting of loans to these immigrants has increased Home

Capital Group’s credit profile.

We think the shares are undervalued, and even if the multiple does not expand, the EPS is growing at a 15%+ CAGR

(much greater than the Big-6) for the next 3 years implying we believe HCG will be one of the best performing financials in

the Canadian market.

We believe that HCG exhibits a better earnings growth and ROE profile, at improving credit quality versus the Big-6, while

also being a very liquid security

We expect a cooling off of housing market. Although there is oversupply of houses, it is predominantly in the condominium

markets in metropolitan cities, which HCG is rarely present. Existing resale prices are expected to stabilize, and existing

home sales are down. We wonder if YoY sales decline is a predictor for YoY price decline to come in 2013.

Bull Arguments outweigh Bears – Legislative changes will be a major factor in increasing the

market share of Alt-A loans

53

Bulls and Bears

Bull Arguments

The Alt-A market has strong fundamentals with limited

competition

Credit loss history is limited and Home Capital Group is

well capitalized to sustain losses

Valuation is attractive and trading at a much lower P/E of

P/BV

Home Capital Group is being discounted because of

negative global economy concerns of a housing bubble in

Canada

Home Capital is strong Earnings growth and has reported

record earnings in the recent quarter

Legislative changes by OFSI will increase market share

of Alt-A loans

Bear Arguments

Housing Price Correction would negatively effect Home

Capital Group.

Entrants who left the market in 2008 re-enter originating

Alt-A mortgages

Low interest rate environment has compressed NIM

Global economic uncertainty could negatively effect the

Canadian economy.

Losing relationships with mortgage brokers

Home Capital is exposed to higher risk assets and

potentially more arrears and defaults.

Bull Arguments outweigh Bears – Legislative changes will be a major factor in increasing the

market share of Alt-A loans

54

Appendix - Credit Rating

Investment grade Trust Company

Home has the highest capital ratios in Canada compared to

other publicly reporting deposit taking financial insitutions


Credit Rating Home Capital Group Home Trust Company

DBRS S&P

Fitch

Rating DBRS S&P

Fitch

Rating

Long-Term Rating BBB BBB BBB BBB(high) BBB+ BBB

Short-Term Rating R2(middle) A-2 F2 R2(high) A-2 F2

Outlook Stable Stable Stable Stable Stable Stable

Section IX

Appendix

56

Appendix - Research Summary

We expect HCG to benefit from lending

opportunities in the Alt-A market outside Ontario,

as well as market share gains at the expense of

rivals that have tightened lending criteria in view

of added regulatory scrutiny.

Shubha Khan

(National Bank Financial, Oct 2012)

We do not believe that the market attributes any

value to growth catalysts like MBS strips, loan

wholesaling and growth resumption in the credit

card portfolio, all of which we have not included

in our forecast at this time. Fred Westra

(Industrial Alliance Securities, Oct 2012)

(C$ millions except per share data and where otherwise stated)

Revenue NI EPS

Firm Date Rating Target FY2012E FY2013E FY2012E FY2013E FY2012E FY2013E

Macquarie 22-Oct Neutral $55.00 $440 $502 $220 $254 $6.33 $7.31

Industrial Alliance 30-Oct Outperform $70.00 $434 $494 $219 $252 $6.36 $7.30

M Partners 1-Nov Outperform $65.00 $436 $504 $218 $248 $6.38 $7.09

Scotia Capital 6-Sep Neutral $58.00 $435 $498 $218 $244 $6.30 $7.03

BMO CM 2-Aug Outperform $54.00 $432 $490 $216 $246 $6.25 $7.10

National Bank 25-Oct Outperform $60.00 $431 $491 $220 $252 $6.35 $7.25

Average $60.33 $435 $497 $219 $249 $6.33 $7.18

57

Appendix - Research Summary

Macquarie– Initiating Coverage

“We are initiating coverage of Home Capital with a

C$54.00 price target and an Outperform rating. We

believe the company will continue to lead its industry

counterparts in areas such as return on equity, efficiency

and credit quality.” (Price at this time was $45.93 2010)

“The loan book is retail-oriented and not exposed to the

deceleration in business loan growth experienced by the

banks. Sluggish demand and cheaper funding options

have limited growth in the business book.”

“We believe Home Capital can maintain credit quality and

respectable loan growth in a cooling market.”

As of Oct 25th 2012, the analyst has a price target of

$55.00 which will be reiterated higher based on off-

balance treatment for single family insured mortgages

Industrial Alliance– Initiating Coverage

“Home Trust’s competitive advantage comes from its

diligent underwriting where each loan is treated

separately and undergoes extensive and customized

risk evaluation practices at the point of origination.”

“We are certain that the near-prime market share is

expanding”

“Moreover, they track and drill down to understand

property values, not only at a regional or jurisdictional

level, but even down to which end of the street is

better.”

“HCG’s overall portfolio average LTV stands at 69.6%,

which provides significant cushion against falling

housing prices in a housing correction.”

As of Oct 31st 2012, the analyst says they maintain

their $70.00 target price based on a blended 10x

EPSNTM of $6.80 and 2.3x forecast BVPS in 12 months

of $30.87. The 40.7% total return warrants a STRONG

BUY recommendation.

The stock trades at a sizeable discount to

the Canadian banks and this is partly attributable to concerns over the housing

market. Also the stock trades at a 45% discount to its historic levels on a PE basis. We think HCG should trade more

in line with bank valuations especially since it has a better earnings growth and ROE profile, and it is a liquid security

(1.7B mkt. cap).

58

Appendix - Drivers of Alt-A

Immigration

Appendix- House Price Index

59

Appendix - Canada Housing Supply Factors

60

Appendix - Vancouver Housing Supply Factors

61

Appendix - Montreal Housing Supply Factors

62

Appendix- Calgary Housing Supply

63

Appendix - Residential Sales Volume

64

• “New mortgage rules continue to

keep a lid on national sales

activity” – CREA President

• Vancouver saw a 32% decline in

sales activity from 2011

• The belief that prices are coming

down may also be a driver of

decreased sales activity.

• Sales activity is falling primarily in

urban areas.

Source: CREA

Significant declines in sales activity is a sign the changing mortgage policies are

having an effect and cooling the mortgage market.

65

Appendix - Insurance Co.

How mortgage insurers fit into the food chain

66

Appendix - Current Balance Sheet

Capital Structure (Capital IQ)

Home Capital Group will have about 7.4B on-balance sheet securitized loans for Q3/2012

They have a total loan portfolio of 16.97B (10.8% YoY growth) with low provisions (0.05%)

The company is adequately financed with GICs, and has a large cash buffer in the case of a fall in housing prices with a Tier

1 Capital Ratio of 17.1%

FY 2011 (Dec-31-2011) Capital Structure As Reported Details

Description Type Principal Due (CAD) Coupon/Base Rate Floating Rate Maturity Seniority

5.20% Debentures Bonds and Notes 153.3 5.200% NA May-04-2016 Senior

Canada Mortgage Bond

Liabilities

Bonds and Notes 6,231.3 2.800% NA - Senior

Mortgage-Backed Security

Liabilities

Bonds and Notes 2,417.8 2.500% NA - Senior

HCG’s Securitized Assets in CMHC Pools

Appendix - Balance Sheet*

67

* Balance Sheet taken from Industrial Alliance Securities Analyst

Documents

Home Capital Group Initiating Coverage (HCG-T)