Those were the first words out of my mouth yesterday upon hearing an incredibly shocking story.
Scott and I had just finished up a meeting at Raymond James with an IT expert who was showing us a demo on some software that might make make some of our internal operations easier, when we stopped by to say hi to a business associate within Ray Jay.
To be sure, our business associate at Ray Jay we stopped in to say hi to is a very high-quality individual, so I believe what he told us. Here goes. And to be clear, I am not making any of this up.
Our guy at Ray Jay was talking to an unidentified Portfolio Manager (PM) at a firm registered in BC. This PM said he would do stock trades with Ray Jay, on behalf of his clients, but would want a "kick back" of sorts.
The proposal from this PM (I could use several other adjectives for this guy but they wouldn't be appropriate for our family-friendly website) was that he wanted to "add on" to the stock trading commission that Ray Jay charged his firm so he would be charging his clients more.
Here is how this PM's proposal would work:
To which I replied, "You've got to be kidding me?". Nope, that was the fact. And this PM said the British Columbia Securities Commission said it was "ok" to operate this way! Really?
Guys like this give the financial services sector a bad reputation.
But in the end, the clients would have no idea that they were being charged an extra $.02/share. How would they? What a joke.
As a PM registered with the Ontario Securities Commission (OSC) and in BC, Alberta and Sask, I would be shocked if a regulator said this form of business practice was "ok". And even if they did, what PM would actually do that?
As a PM in any jurisdiction in this country, we have a Legal Obligation to operate with a Fiduciary Duty to our clients. This means putting our client's interests ahead of our own at all times. How does over-charging your clients put their interests ahead of your own?
Stories like this are just part of the reason why we created Our Voluntary Code of Conduct for the Stewardship of Your Wealth (read here if you haven't already: highrockcapital.ca/uploads/3/4/2/5/34254660/our_voluntary_code_of_conduct_as_stewards6.pdf). The first two are extremely important, certainly in relation to this story we heard yesterday:
1) Put our client’s interests ahead of our own
2) Be transparent and forthcoming about fees and costs and their impact on your portfolio
Last thing, before I sign-off on this topic, that clearly has me worked up into quite a state, below is a full explanation of our High Rock Private Client Fees:
And for further clarity, let me add:
Well the OSC, nor their other provincial counterparts, may not think full fee disclosure is all that important, but at High Rock, we do, and we have gone above and beyond the regulatory requirement to help educate our clients and prospective clients exactly what they are paying, what we are making and what anyone else involved is making.
Here it is:
If you didn't know already, you will after reading this...global stock markets have put in a pretty rough day. The Dow is -370pts or 1.77%. Not a good day if you are 100% invested in Stocks (and most of the new clients we see transfer into High Rock are in fact just that...100% stocks. Crazy!).
Lots of reasons circulating about why the market is selling off in such dramatic fashion but here are some:
Notice three things about this chart:
Three for three. Yikes, is that a strike-out? No umpire so we will wait for Father Time.
I am almost 100% certain that our portfolios at High Rock will be lower tomorrow morning when we walk in, however, they won't be down anywhere near the same as the stock market. Why not? Two main reasons:
Returns are the result of proper risk management.
I wanted to write about China and this is, sadly and embarrassingly, the only moderately witty title I could come up with. Not terribly creative, I know, but I did like the song back in the '80's.
I wrote a blog back in Sept/16 about China and the offshore yuan etc. It was a bit technical in nature but feel free to re-read it here: highrockcapital.ca/pauls-blog/the-last-time-this-happened-in-china-the-world-stock-markets-sneezed
Today, I wanted to keep it a little lighter. I noticed a few things about China recently that have me somewhat concerned about the state of the global economy.
First of all, China continues to devalue to yuan (the Chinese currency). They are likely doing so for two main reasons: 1) to spur exports to the USA and 2) to export the deflation in China along with their exported goods. When China devalues their currency, it is not really a great signal for the global economy. (Remember, higher on the graph is a weaker yuan). Exhibit A:
Second thing I noticed is the price of Iron Ore has been..."smoked" (old trader-speak for hammered hard, slammed, monkey-hammered....you get the picture...it declined). Not a good sign. Exhibit B:
And the third thing, it the result - the Chinese stock market has been hit pretty hard from its high point showing a decline about 10% since early April. Exhibit C:
Riposa in Pace David Bowie.
I have been spending a lot of time the past few weeks researching the residential Canadian real estate market, Home Trust/Capital and Equitable Bank. We had no exposure to any of the above (other than personally, most of us own a house) but when there are such serious dislocations, and retail investors are involved, there is always opportunity, so to work I went. (Full disclosure, we now have some exposure...at what I believe to be the right risk/return profile).
Part of my research was hopping on a conference call on Tuesday that National Bank Financial (NBF) hosted on the topic. It was actually a pretty good call with various NBF Economists and Analysts giving their research/views on what has been happening in both the residential real estate market and Home Trust/Capital.
I won't go into the dislocation I think I uncovered from retail investors, but I thought I would share a simple perspective on some views on the Canadian residential real estate market.
First, no question, housing prices in Canada (especially Montreal, Toronto and Vancouver - and their suburban areas) have shot up like rockets the past year. The reason why is varied from low interest rates, immigration, economic growth, etc.
Here is a chart to show just how crazy the the price appreciation has been the past year or so:
Looks a little bit too much, doesn't it?
However, if we look at another metric, one I have thought about, anecdotally, for about the last 15 years, we can see that Canadian major city home prices are actually...cheap, on a global scale. Have a look at Montreal, Toronto and Vancouver home prices vs income levels:
Look at that. Montreal is the cheapest of the bunch and Toronto is third cheapest. Keep moving to the right of the chart...some you would expect to be more expensive than our three big Canadian cities, but others, hmmm. Buenos Aires, Stockholm, Montevideo, Rio...heck even Paris and Rome, given the fiscal situation of the Eurozone puts the nations of these two cities in awful shape (but tourists still like to go there). And then of course we have the expected cities as the most expensive like London, Beijing and Hong Kong.
I remember about 15 years ago, a Consultant (who was German and from Frankfurt) from McKinsey was transferred to Toronto and bought a brand new build house about four down from our house. The small neighbourhood we live in was all-a-buzz about the fact that these crazy Germans paid an unheard-of-at-the-time price for the neighbourhood of $2.25mm. I remember meeting Franz (not kidding, I think that was his name) at a neighbourhood Christmas party shortly after they moved in. I sort of said, "Wow, thanks for single-handily moving the price of the neighbourhood up". His response was simple and factual, "Housing in Toronto is so cheap. There is no option to live 6kms from the office downtown in Frankfurt, but if there was, it would have cost me twice as much to have a large house like this and so close to downtown". There you have it. (They got divorced, sold the house and moved out about 7yrs ago).
So, yes, home prices have moved up way too fast over the past year but maybe they are just playing catch-up on a global basis? I think they will likely stabilize here and I put about 0.5% probability of another 33% year of price appreciation. However, maybe there will be a solid base put in for Canadian home prices given how cheap they are on a global basis? With Toronto being the fastest growing city in the developed world and with huge immigration numbers, there may be a support bid not too far beneath here. Stabilization at this level or slightly below would be a good thing and then the price appreciation chart (first chart) wouldn't look so "expensive" given the past year would roll off. Time will tell.
Some of this I wrote about in an Open Letter to the PM and Min of Fin back in July 2015 (I never sent the letter to them, but maybe should have). highrockcapital.ca/pauls-blog/open-letter-to-prime-minister-trudeau-and-finance-minister-morneau-on-the-state-of-the-housing-markets-in-toronto-and-vancouver
What I should do, is update the Compound Annual Growth Rate (CAGR) of an average Toronto house vs Royal Bank stock over the past 20 years. Maybe for next week but I bet, even after the past year's move in Toronto home prices, Royal Bank stock is still way ahead of the average Toronto home price on a 20 year CAGR basis.
There has been an awful lot of news on these two alternative mortgage originators over the past week so I thought I would write a blog on what is going on with them, how it might affect our High Rock clients and the potential fall-out on the Canadian housing market.
First of all, High Rock clients never owned any Home Capital (Trust) Stock, GIC's or overnight High Interest Savings Accounts (HISA). We smelled a hornet's nest some time ago. In fact, about one-and-a-half years ago, in one of our Institutional mandates for Scotiabank, we were actually "short" Home Trust Co senior unsecured bonds. We were short them at a dollar price of around $100.50 and they are now at $85.00 (remember being short means you sell at $100.50, borrow the bonds to deliver to the buyer, and then buy back when the bonds fall so being "short" means one has a negative view of the company). With a negative view, we obviously were never "long" or invested in any part of Home Capital at any time. Rest easy.
As for Equitable, we used to park our excess cash in their overnight HISA. I know the CEO personally (not well, but have cycled with him once per year over the past 6 years...not that cycling with a CEO once per year is a reason to invest in a company). Regardless, we have not owned Equitable HISA for over half a year.
As nice as Andrew Moor is (and he is a very nice guy), we decided to revert to the most simplest of rules with regards to investing in financial institutions (yes, even buying an overnight HISA deposit is investing...remember ABCP (Asset Backed Commercial Paper)?. That simple rule as is follows: A Financial Institution (FI) usually borrows short term (overnight out to 90 days) and invests in loans (mortgages in this case) that typically have a longer term like 30 years (typically 5yr rate resets). Once the FI loses it's ability to fund it's business...it is done. They need constant access to capital at the right cost of capital to continue to make the business model work.
With an overall negative firm (High Rock) view on Home Capital, we thought there would be possible funding contagion to Equitable as well, and so, months ago, we moved our cash overnight deposits to a large Insurance company. Now these insurance companies are largely doing the same thing (borrowing short term funds and investing in longer term assets, like mortgages) but to no where near the same degree as Home and Equitable. And then we got even more conservative about two weeks ago and moved our overnight cash from this large insurance company to a large Canadian bank. If I get even more nervous, it will quickly move to t-bills.
You may ask, "but aren't these Home and Equitable Bank HISA and GIC's covered by the Canadian Deposit Insurance Corporation (CDIC)?"
Sort of. Only accounts up to $100,000 are covered by CDIC insurance. Accounts over that amount are left as "unsecured creditors" so if something bad happens (insolvency) with that deposit-taking institution, you are standing in line with your claim waiting (more like hoping and praying) to get some of your money back. And the real problem with CDIC insurance is the following: even though your <$100,000 deposits are insured, who knows how long it would take to get paid your cash back in the event of a default? No one seems to really know how this "workout" works out. My idea of cash is that it is readily available. I don't want to stand in line and wait 30 days, 60 days etc etc. No thanks.
So think about all of the Advisers (note the "e" here, not an "o") at the banks and dealers who put their clients in Home or Equitable because they picked up an extra .25% on their HISA or GIC's? And then remember how the ABCP at Coventree came to an abrupt end? I do. I had a front row seat as the Head of Canadian Credit Trading at Merrill Lynch Canada. Merrill, like most other FI's in Canada, was a liquidity provider to Coventree. I won't go into detail about what happened (call if you are interested and have 3 hours to spare) back then with ABCP but I am acutely aware of how FI's fund and how to avoid an embarrassing situation.
Now think about all these Advisers today. Some may have shorter memories than others but I would think it would be very embarrassing to have your client money stuck in Home or Equitable HISA or GIC's. In fact, what we have uncovered the past week is that the banks themselves are not even offering their Adviser network any Home deposits over $100,000 (so only insured deposits). That is to say, the banks themselves don't want to deal with a potentially embarrassing situation.
And you might say, "But Home just got a $2 billion lifeline?"
Yes they did, but it is up to $2bln of secured financing that came at an extremely high cost of capital (~20%), so much so that the business model doesn't make sense (borrowing at 20% from HOOP to lend out mortgages at 4%?). The reason why Home stock and bonds got hammered last week was because this $2bln secured line of "rescue financing" or "debtor in possession (DIP) financing", effectively "primes" the stock and bonds. What "primes" means is that Hospitals (HOOP) needs to be paid back in entirety before any unsecured bonds get paid back (forget about the stock). Bottom line for Home - they have lost access to the capital markets and funding and that ain't good.
Compare Home's lifeline with HOOP at 20% to Equitable's lifeline at ~3%. First of all, all 6 Canadian Banks sound like they are in the syndicate as back-stop lenders to Equitable so clearly the Banks have much more confidence in Equitable than Home. Also, it is not even clear whether Equitable will need to draw-down part of their $2bln backstop facility.
"How will this affect the Canadian housing market?"
There is a case to be made that as mortgages come up for refinancing (certainly at Home) that they will not be able to refinance them due to their new cost of capital being so high. If Home is unable to refinance these mortgages, those mortgages may look to other providers, like Equitable. Now Equitable just got a $2bln standby line of credit by all 6 Canadian Banks (Equitable likely won't even need to draw any of that down due to their longer-term funding schedule) so I suppose they will have excess liquidity to pick up some of Home's mortgages, should they like the credit quality of those mortgages. Either way, there will likely be some pressure on the lower-end of the housing market due to this funding pressure on Home.
At the end of the day, we will be extremely cautious with how we invest our excess cash. It is beyond tricky out there right now.