Home Capital Group (HCG.TO or the “Company”) has done three things right so far:

1. Cut the dividend as anticipated.
2. Announced that $325 million of bonds due May 24, 2017 will be repaid. That was also expected, given its line of credit from HOOP.
3. Rejigged the board via the addition of individuals that bring credibility and an expectation of better governance going forward.

The stock price has accordingly moved higher, and investors now seem to be betting that the company can survive. The Company also announced that a third-party has agreed to buy as much as $1 billion in qualifying uninsured mortgages from it, with an immediate commitment to buying $500. The expectation is that arrangement will expand later.

More importantly, Home Capital also said that:

1. We are tightening our lending criteria and reducing broker incentive programs.
2. Expect a decline in originations and renewals.
3. Mortgage originations are meant for sale and not to be maintained on balance sheet, given funding challenges.

That implies higher costs, lower volumes, lower profitability and a long road to revival. More importantly, Equitable Group Inc. (EQB.TO) and First National Financial (FN.TO) have already alluded to declining single family originations, tighter NIM (30 bps in the case of EQB) and an overall slowdown in activity. With Home Capital now competing more aggressively for the securitization conduits of lenders, it is inevitable that Street Capital Group Inc. (SCB.TO), EQB, FN and others in the space will suffer margin compression as well.

Lower margins, slower volume growth and under provisioned for loan-losses (real estate prices only go up after all) earnings disappointments are in store for entire sub-prime lender space. While the Company may survive the road to redemption is treacherous. The easy money in HCG has been made.

We expect that May 11, 2017 could bring disappointing news with the company projecting a loss for 2017 and not much better news for 2018, causing the stock to be highly volatile. If a sale is off the table, which looks increasingly likely, then underperformance is definitely on the cards. Tread with caution.