Winner in world’s biggest housing boom defies short-seller noise
Perhaps no one has made more money off the world’s biggest housing boom than Canadian financier Stephen Smith.
But as Smith tells it, he built his fortune — estimated by Bloomberg at about $3.6 billion — without ever needing property prices to soar.
That’s largely thanks to investments he made in Canada’s mortgage market over the past three decades — betting against a crash that many, including waves of American short sellers, had come to expect.
By the time prices actually did begin to fall last year, as the Bank of Canada ratcheted up interest rates, most of the shorts had given up. And as Smith sees it, the worst of those declines are now over.
When he agreed to pay C$1.7 billion ($1.26 billion) last year to acquire mortgage lender Home Capital Group Inc., the company’s shares had tumbled on fears over the housing market’s slide, and Canadian borrowers were already among the most indebted in the developed world.
“My belief is it has to be a depression-type of scenario before you’re going to have any issues,” Smith, 71, said in an interview at his Toronto office.
Smith was never bullish on the value of Canada’s real estate, but the prudence of its mortgage rules. He says he is the rare finance type who feels “blessed” to have a regulator.
“Mortgages that are done in Canada are really done directly or indirectly through officially regulated institutions,” Smith said. “That’s what I’ve bet on.”
The federal government exerts influence on the mortgage business in various ways, such as encouraging lenders to maintain a kind of floor for underwriting standards across the industry. At least so far, that’s helped make Canada’s housing market more resilient, and the lenders less prone to losses.
It was Canada’s housing downturn of the 1980s — when mortgage rates neared 20% — that ended Smith’s interest in having direct exposure to property values. At the time, he was building townhouses in downtown Toronto and was forced to declare personal bankruptcy when his borrowing costs became greater than what he could sell the properties for. He says he’s never invested directly in real estate again, aside from homes for his personal use.
It wasn’t long after that Smith and a partner, Moray Tawse, founded their mortgage lending venture, First National Financial Corp., in 1988. The company remained small but profitable through the recession of the early 1990s because of Canada’s mortgage rules: Lenders can pursue borrowers for losses even after the underlying collateral — the home — is sold. That means Canadians have a strong incentive to keep paying their mortgages even when things get tough. Mortgage-default insurance is typically required for borrowers who put down less than 20%.
And then, as the US housing market began to crack in 2006 and 2007, Canada’s regulators gradually mandated stricter underwriting rules. The maximum amortization of a mortgage was reduced to 35 years from 40, and 25 for insured borrowers. The riskiest borrowers were barred from continually using gains in a property’s value to refinance their loan rather than pay it off, and new borrowers were required to undergo stress tests that ensured they could handle their loan payment at much higher interest rates.
“Focusing on the ability of borrowers to repay needs to be fundamental,” said Jeremy Rudin, who helped design and implement these regulations as an official at the federal Ministry of Finance, and then ran Canada’s banking regulator. “The risky tendency in residential mortgage lending is to lend solely on the basis of the property value, to think, ‘I don’t have to care very much about whether the person will be able to pay back this loan because I’ll be able to seize the property and get my money back.’”
As this regulatory framework took shape, Smith doubled down on Canadian consumer lending.
When American International Group Inc. was forced to sell its Canadian mortgage insurance business in the wake of the US crash, Smith partnered with Ontario Teachers’ Pension Plan to buy it in 2010. And his strategy behind the 2021 purchase of consumer lender Fairstone Financial was to have it go from financing itself in the market to taking deposits, which requires complying with more regulations.
“He had faith that as long as people had jobs, that was going to keep the mortgage market going,” said Jim Leech, who ran Ontario Teachers’ at the time of the AIG deal. “Their home is their greatest asset and they will do everything they can to keep it.”
Even Smith’s old business partner at First National and members of his own family questioned whether it was wise to keep increasing exposure to Canadian borrowers. But Smith says whenever he stress tests the portfolios of regulated mortgages at one of his businesses, he finds they hold up in all but the most catastrophic scenarios.
“They thought it was a real serious error,” he said. “I like the regulated framework. So I’m a bit of a value investor in that sense."
The same considerations applied when assessing the Home Capital purchase in the midst of the current housing market downturn, which has already seen prices nationally fall 16% from their peak last year. Because Canada’s regulations ensure borrowers have the income to pay their mortgages even at around current rates, assuming they stay employed, Smith doesn’t foresee a lot of people being forced to sell their homes. Even if values have a little further to drop, or they just bounce along from here, Smith expects the worst of the housing market correction is over. And sooner or later, he believes the combination of a growing population and constrained housing supply will spur a recovery.
“People are still paying their mortgages,” he said. “Is there any stress? Nope. So I just saw this as an opportunity.”
That rebound might already be taking shape. Nationally, prices fell at their slowest pace in nearly a year in February, and more recent data from Toronto and Vancouver suggest they’re already starting to bounce back.
Not everyone is so sanguine. David Rosenberg, an economist who predicted the US housing crash, says the current correction in Canadian home prices is only half over, maybe less, because values remain so inflated compared to economic fundamentals like income. With price declines of the magnitude he expects still to come, Rosenberg says even the most prudent underwriting may not be enough to prevent mortgage losses.
“You can’t just say people are going to pay their mortgages because, depending on how far home prices go down, all of a sudden if you’re left with negative equity in your home, you’re going to hand your keys back to the lender,” he said. “Anything that touches the mortgage market I’d be staying away from. At a personal level, my last trade was to get out of mortgage investments in Canada.”
The anxiety cropping up over the housing market could also see a new round of rule-making, which may hinder mortgage businesses’ profitability. Canada’s banking regulator is currently consulting with the industry on a proposal to limit loans deemed to represent too high a proportion of a borrower’s income.
That could make business more difficult for Home Capital, which targets borrowers with irregular income streams — contract workers, the self-employed and new immigrants.
When it comes to this particular proposal, Smith said it might be one rule too many, and he plans to participate in the regulator’s consultations.
At the same time, he’s looking for further acquisitions. And while he says he’s open to buying different types of businesses, he’s still inclined to stick to financial services.
“He doesn’t exactly have a well diversified portfolio,” said Leech, the retired pension fund chief. “But you sure wouldn’t want to bet against Stephen Smith.”