Warren Buffett's Berkshire Hathaway Inc (BRKa.N) is providing a C$2 billion loan to Home Capital Group Inc (HCG.TO) and taking a 38 percent stake in the mortgage lender, a move which is pressuring short sellers who targeted the stock as Canada's housing market has turned riskier.
Shares in Home Capital (HGC.TO) closed up 27 percent on Thursday.
Shares in other Canadian alternative lenders also rose on Thursday. Equitable Group Inc (EQB.TO) closed up 12.5 percent. Street Capital Group (SCB.TO) closed up 8.3 percent. Shares in mortgage insurer Genworth MI Canada Inc (MIC.TO) were up 11.5 percent.
The deal may bring to a close a two-month effort by Home Capital's board, and advisers RBC Capital Markets and BMO Capital Markets, to replace a costly credit facility with the Healthcare of Ontario Pension Plan (HOOPP) and shore up the lender's balance sheet.
The credit facility was arranged earlier to provide funding for Canada's largest non-bank lender which had suffered from the withdrawal of 95 percent of its high interest deposits in the past two months.
Alan Hibben, a former Royal Bank of Canada (RY.TO) executive who was recruited to the Home Capital board last month, said over 70 parties had expressed interest in investing in the lender.
In an interview, Hibben said Home Capital was drawn to Berkshire Hathaway because of Buffet's credibility with both investors and depositors.
"The board decided it would be nice for a sponsor to give us a view where somebody could say 'wow, if that smart person thinks the Home Capital business model and portfolios are good, I'm going to think that'," he said.
Hibben said Buffett had become involved "later in the process" with Home Capital approaching Berkshire Hathaway rather than the other way round.
Home Capital has played an important role in Canada's mortgage market, lending to new immigrants and self-employed workers who may not be able to get loans from the country's biggest banks.
But home prices in Toronto and Vancouver have fallen after the government introduced measures to cool overheating prices with household debt in Canada has reaching record levels.
Investors are wondering whether the deal will be as successful as Buffett's decidedly bigger deal to buy Goldman Sachs (GS.N) preferred shares during the global financial crisis in 2008.
“Home Capital’s strong assets, its ability to originate and underwrite well-performing mortgages, and its leading position in a growing market sector make this a very attractive investment,” said Berkshire's chairman Warren Buffett, in a statement on the deal released by Home Capital on Thursday.
SHORT SELLER NOT CONVINCED
Short sellers are continuing to take positions in Home Capital though, aiming to profit by selling borrowed shares on the hope of buying them back later at a lower price.
Combined short interest in the company's Canadian and U.S.-listed shares (HMCBF.PK) stands at about $183 million, up $62 million this month, according to data from financial analytics firm S3 Partners.
Marc Cohodes, a short seller who has been betting against Home Capital for two years, said on Thursday he continued to do so.
"If it wasn't Warren Buffett's name, the stock would be way, way way, down today," he said in an interview.
Home Capital was forced to raise new capital after depositors rushed to withdraw funds from its high-interest savings accounts.
They pulled 95 percent of funds from Home Capital's high-interest savings accounts since March 27, when the company terminated the employment of former Chief Executive Officer Martin Reid.
The withdrawals accelerated after April 19, when Canada's biggest securities regulator, the Ontario Securities Commission, accused Home Capital of making misleading statements to investors about its mortgage underwriting business.
Home Capital reached a settlement with the commission last week and accepted responsibility for misleading investors about mortgage underwriting problems.
"The 'endorsement' from Warren Buffet may prove to rehabilitate depositor confidence, thus turning deposit flow positive," said National Bank of Canada analyst Jaeme Gloyn.
The Berkshire credit agreement comes with an interest rate of 9.0 percent, with a standby fee on funds not drawn down of 1.0 percent, compared with 2.5 percent previously.
The facility will be in place for a year after which Hibben said the company will assess if it still needs a facility of that size.
"That's an awfully big number for a small bank like ours, particularly as we're going to hold likely a billion dollars of cash," he said.
Home Capital on Tuesday said it would sell a commercial mortgage book, raising close to C$1.2 billion in a deal expected to complete in the third quarter.
Berkshire Hathaway will also take a 38.4 percent stake in the company after buying $400 million worth of Home Capital stock.
It will make an initial investment of C$153 million to buy a 20 percent stake.
The price is a 15 percent discount to the average share price prior to Berkshire's final proposal on June 13 and a 33 percent discount to Wednesday's closing price.
The rest of the shares will be acquired at C$10.30 in a deal that still needs shareholder approval.
Buffett has not been especially active in Canada in recent years.
He was a shareholder in oil and gas producer Suncor Energy Inc (SU.TO) but sold the stake in 2016.