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Home Capital former investor is mulling contagion odds

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The escalation of Home Capital Group Inc's distress last week has led one of its largest former investors to rethink - if only slightly - the prospects of troubles spreading through the rest of Canada.

[TORONTO] The escalation of Home Capital Group Inc's distress last week has led one of its largest former investors to rethink - if only slightly - the prospects of troubles spreading through the rest of Canada.

After the alternative-mortgage lender set up a C$2 billion (S$2.04 billion) credit line to offset a run on deposits, Mawer Investment Management Ltd's Jim Hall is recalculating the odds of a contagion widening across one of the world's strongest financial systems.

"The probability has gone from infinitesimal to possible - unlikely, but possible," said Mr 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, which oversees more than C$40 billion in assets, sold about 2.8 million shares, or a 4.3 per cent 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.

Home Capital has been struggling since April 19, when Ontario's securities regulator accused management of misleading investors over how the firm handled a review of mortgage brokers who falsified documents about borrowers' income. Home Capital shares plunged 65 per cent on April 26 when the loan was announced, and the lender has since disclosed an accelerating pace of declines of its high-interest savings balances - deposits used to help fund its mortgage business.  The firm had C$20.5 billion in assets at year-end, and its C$15 billion home-loan book represents about 1 percent of Canada's C$1.45 trillion mortgage market.

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Mr Hall sees the odds of Home Capital's woes spreading through Canada's financial system as 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," Mr Hall said. "There are firefighters standing around it right now, so if it starts to move, they'll put it out." For its part, Home Capital secured a loan to compensate for a drop in deposits and said it's weighing a sale, hiring RBC Capital Markets and BMO Capital Markets to advise on financing and "strategic options." Even if withdrawals continue, as expected, the new funding should mitigate it, the company said April 26. 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," Mr 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."

Canada's financial system has lots of fire breaks, as Mr 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," Mr 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.

"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," Mr Hall said. "But it doesn't mean it can't get out of control."