Friday, March 03, 2006

Home Equity May Be on Big Banks Radar

Reverse mortgages: Growth potential could attract competition

Financial Post, Duncan Mavin, 3 March 2006

Home Equity Income Plan continues to expand at a rate to make Canada's eager-for-growth banking sector green with envy. But with Home Equity a long way off from fully exploiting the much bigger potential for the reverse mortgage market, the trust could be looking over its shoulder at the banks that might want to muscle in on its turf.

Earlier this week, Toronto-based Home Equity said its reverse mortgage portfolio grew 10% during 2005, to $533-million at the end of the fourth quarter, up from $486.1 million at the beginning of last year.

That translated into stellar income growth too -- the trust's net income was $1.3-million in the fourth quarter of 2006, an increase of $486,000, or 58%, from the same period last year.

Although those numbers are immaterial compared with the sort of earnings demanded by Canada's banks, the reverse mortgage market could eventually be worth significantly more than it is today.

"It's all driven by demographics," said Nav Malik, an analyst at Scotia Capital. The rising number of seniors is well documented, as is a possible pensions crisis due to workers not setting enough aside for their retirement years, which could also coincide with higher costs of living, such as the cost of household energy.

In fact, Home Equity, which currently has 6,200 reverse mortgages secured by residential properties worth more than $1.5-billion, estimated the total potential reverse mortgage volume could reach $7-billion by 2016 in its 2002 initial public offering documents. That's about 14 times the size of the trust's current portfolio.

Home Equity is currently the only national provider of reverse mortgages -- loans secured against your home, which you do not have to pay back as long as you remain in your home. They are only available on homes that are mortgage free, and whose owners are 62 or over. But the growth potential in the reverse mortgage market could represent the sort of opportunity that is of interest to the banks.

In recent weeks, both Bank of Nova Scotia and Toronto-Dominion Bank have shown that alternative sources of growth are on their agenda, announcing acquisitions in sub- or near-prime home and auto lending businesses. Meanwhile, in the middle of the banks' annual meetings season, it has already become clear that the quest for growth opportunities is a key concern for the sector.

And now, the possibility "that one or more of the Canadian banks enters the reverse mortgage markets" is the main impediment to Home Equity's future plans, said Walter Spracklin, an analyst at RBC Capital Markets.

"The potential growth is there, and in the interim, there are very predictable cash flows," said Mr. Spracklin.

He has also noted the banks have suitable national distribution networks to challenge Home Equity's market dominance, and they also already provide Home Equity with about 55% of its business through referrals -- the other 45% comes from call-centre referrals driven by advertising.

In contrast, Home Equity's own expansion plans are being held back by the same referral system, said Mr. Spracklin in an interview this week. To grow at an even faster rate than at present, he said, Home Equity would need to be allied to a network of investment advisors.

Nevertheless, it remains to be seen whether the banks could develop a taste for reverse mortgages.

With the success of Home Equity so far partially dependent on gathering referrals from all the banks, it's questionable whether any one individual bank could tap into the market right away, said Gary Krikler, senior vice- president and chief financial officer at Home Equity. Also, he noted, the reverse mortgage business is difficult to start from scratch because it potentially takes a long time to generate cash flows.

If that's the case, then anyone looking to get a piece of Home Equity's growth market might consider an acquisition makes more sense than starting from scratch.