With the bank run at Home Capital Group hitting a crescendo on Friday, when in one day 36% of the liquidity at Canada's largest non-bank lender escaped through the front door, and only an emergency rescue loan yielding over 20% has prevent a liquidation at HCG so far, suddenly some are wondering if the dreaded "C" word is applicable to what Bloomberg has dubbed "one of the world’s strongest financial systems."
The word in question is contagion, and the party casually bringing it up is Mawer Investment Management, one of HCG's largest former investors.
According to Bloomberg, Mawer CIO Jim Hall is recalculating the odds of a contagion widening across the Canadian financial system.
“The probability has gone from infinitesimal to possible -- unlikely, but possible,” said Hall, chief investment officer of the Calgary-based money manager, in an interview Saturday. “If depositors or bondholders start to lose faith in their banks, well then that becomes systemic.”
Mawer is not waiting to find out either way: the company which oversees more than C$40 billion in assets, sold about 2.8 million shares, or a 4.3 percent stake, in Home Capital in the past week, joining another Calgary-based money manager, QV Investors Inc., in exiting its investment amid the imbroglio consuming the Toronto-based lender.
Speaking to Bloomberg, Hall said that in his view, the odds that woes at Home Capital - which had C$20.5 billion in assets at the end of 2016, and whose C$15 billion home-loan book represents about 1% of Canada’s C$1.45 trillion mortgage market - spread through Canada’s financial system are low, "despite a growing chorus of voices speculating such fears in a nation gripped by an overheated housing market and runaway home prices in two of its three biggest real-estate markets: Vancouver and Toronto."
“It’s a pretty hot fire in one little corner of the forest, and it doesn’t look like it’s spreading,” Hall said. “There are firefighters standing around it right now, so if it starts to move, they’ll put it out.”
Unless, of course, the firefighters are just as capable as the rating agencies or the company's investors, the vast majority of whom never saw this coming.
As reported last week, after admitting it was the subject of a furious bank run, Home Capital secured a loan to stem dwindling deposits and said it’s weighing a sale, hiring RBC Capital Markets and BMO Capital Markets to advise on financing and “strategic options.” Canada’s banking regulator says it’s closely monitoring the situation and surveying other financial firms to assess their condition.
"The assets look, at this point, still reasonably good,” Hall said, adding that Home Capital’s problem is a matter of confidence. “Confidence was lost in this company and the business model breaks apart. That’s the problem with banks.”
So what would a worst case scenario look like?
Canada’s financial system has lots of fire breaks, as Hall describes it, to prevent problems from spreading.
“Even if a bank gets itself into a confidence issue, it can be effectively bailed out by another bank or by another financial institution or by ultimately the regulator,” Hall said.
Bank failures in Canada’s financial system, deemed the world’s soundest by the World Economic Forum for eight straight years until 2016, are rare. Canadian banks sidestepped the worst of the 2008 financial crisis, having only a fraction of the $1.95 trillion of writedowns and losses suffered by financial firms worldwide.
Ultimately, it is the "safest" financial systems, those that have taken virtually no reserves against a downside case, that end up being most exposed to unexpected shock factors.
"In a system that’s well capitalized, there are lots of firefighters around and they’ve got lots of equipment and they’ve got lots of water - that’s kind of where we’re at right now,” Hall said. “But it doesn’t mean it can’t get out of control." As a reminder, in the US stocks surged for months after the US had its own "New Century" moment, hitting all time highs nearly half a year later, when it took months for the market to digest just what the collapse of subprime meant for the US and global economy.