Joel writes in with an interesting question.
I’ve noticed you’re not a fan of Home Capital Group (TSX:HCG) and from your comments it makes sense to me. On the other hand though, you’ve written about First National Financial (TSX:FN) and their juicy yield. Any reason why you like FN over HCG?
Good question Joel. Unlike all those other questions I get, which are pure dog crap.
Who are you?
What are you doing here?
Why are you taking off your pants?
I DON’T HAVE TIME FOR ANY OF THOSE BAD QUESTIONS, TAYLOR SWIFT. WHY CAN’T YOU JUST SHUT UP AND ACCEPT MY CREEPY STALKING?
First National and Home Capital have a lot in common. They both heavily securitize their mortgages, which means they package them together and sell them to investors. The difference is one packages up (mostly) CMHC insured loans, while the other packages up some CMHC-backed loans and some non-CMHC loans.
Home Capital has just under $26 billion worth of loans outstanding. Here’s how they break down:
Now the way the mortgage market works is Home Capital has traditionally been able to buy bulk mortgage insurance on at least some of its uninsured loans (I explained more about the bulk insurance practice here). But certainly not all of these loans are protected by insurance. There’s also close to $1 billion in credit card loans, lines of credit, and “other consumer retail loans.”
In other words, I’m not a huge fan of the portfolio. There’s too much crap I think gets impaired in a big way when the Toronto housing bubble pops.
Compare that to First National. This is from March, 2016 but is still accurate. Note the last line:
About 80% of First National’s mortgages are backed by a mortgage default insurer. The next 15% are conventional mortgages with more than 20% down. These aren’t much of a risk because First National has focused on AAA customers. That leaves us with just 5% of the portfolio in multi-unit, commercial loans or bridge financing.
Basically, I like First National’s portfolio much more than Home Capital’s. First National deals with prime borrowers. Home Capital doesn’t.
The mortgage servicing business
Both Home Capital and First National heavily securitize their mortgages. The loan is sold off to whoever while the company gets paid to service it. The servicing business is fantastic.
In 2016, First National did $1.05 billion in revenue and made $196 million after tax. This gives it post-tax margins of just under 20%. That is a succulent business.
First National also makes a little money when it sells the loans to investors and also makes money doing bridge loans.
Growth in the broker market
I also like First National as a way to play growth in the mortgage broker market.
The internet has democratized the mortgage process. All it takes is four seconds on Google to see if you’ve gotten a good rate or not. People with good credit will insist on getting the lowest rates possible.
This is good for the mortgage broker market. They’re done a decent job marketing themselves as the low rate leaders. First National is one of the biggest mortgage broker lenders with consistently low rates. It’ll benefit as this trend continues.
I think First National is a somewhat decent value stock, although I don’t own any myself. It trades at less than 9x trailing earnings; it’s obvious the market thinks earnings go down next year, most likely thanks to the new mortgage rules making it tougher to qualify.
Even if earnings do fall, I still think the dividend is relatively safe. The annual payout is $1.95 per share while the company made $3.28 in 2016. That represents a 7% yield.
Disclosure: No position in any stock listed and no plans to buy, either.