HOME CAPITAL GROUP INC. $38 (Toronto symbol HCG; Aggressive Growth Portfolio, Finance sector; Shares outstanding: 34.5 million; Market cap: $1.3 billion; SI Rating: Extra risk) is the parent company of Home Trust Company, a federally regulated trust company that specializes in residential first mortgages to small business owners, the self-employed and others who don’t meet the stricter criteria of larger, traditional lenders.

Home Trust’s mortgage lending is primarily funded by retail deposits. Home Trust takes deposits in the form of short-term deposits, guaranteed investment certificates, registered retirement savings plans and registered retirement income funds. The trust earns money on the spread between the interest it receives from homeowners, and the interest it pays out to the buyers of these securities.

The company operates just six branches in Ontario, Quebec, Nova Scotia, Alberta and British Columbia, so it gets most of its business through independent deposit and mortgage brokers.

Residential mortgages account for over 80% of Home Capital’s revenue, and 70% of its earnings. The remainder comes from consumer loans, commercial mortgages and credit cards.

Home Capital’s revenue jumped from $112.6 million in 2002 to $291.3 million in 2006. Earnings grew from $0.59 a share (total $20.6 million) in 2002 to $1.95 a share ($67.8 million) in 2006.

In the three months ended September 30, 2007, earnings rose 35.4% to $0.65 a share (total $22.8 million) from $0.48 a share ($16.6 million) a year earlier. Revenues grew 33.6%, to $94.3 million from $70.6 million. Total assets increased 27.0%, to $4.7 billion from $3.7 billion.

Credit Cards Cut Mortgage Risk

The company has expanded into other areas to cut its reliance on mortgages. For example, its Equityline Visa credit card lets cardholders borrow against the equity in their homes. At September 30, 2007, receivables on Equityline Visa cards totaled $291.8 million, up 63.2% from $178.8 million a year earlier.

Another successful product for Home Capital is pre-paid Visa cards, which it issues to customers with bad or no credit. Cardholders deposit up to $10,000 with Home Capital and pay a monthly fee. They can then charge up to the amount of their deposit.

This acquisition looks promising

In October 2007, Home Capital acquired Payment Services Interactive Gateway Corp. for roughly $17.6 million. This business offers online payment collection and financial transaction processing systems and services to North American Internet-based merchants.

In late 2006, the company re-entered the commercial mortgage market. It feels its expertise with residential mortgages will keep its credit risk low. During the first nine months of 2007, Home Capital’s commercial mortgage group advanced loans for $406.7 million.

Another area of growth for Home Capital is wealth management. It recently received approval from the Ontario Securities Commission to offer investment counseling and portfolio management services.

Loan losses are low

Despite targeting riskier borrowers than those serviced by larger banks, Home Capital is doing a good job controlling credit losses. At September 30, 2007, bad loans represented just 0.63% of Home Capital’s total loan portfolio. That’s up from 0.56% a year earlier, but down from a peak of 0.74% at March 31, 2007.

The company is also doing a good job controlling costs. Its efficiency ratio (non-interest expenses such as salaries and building costs divided by revenue — the lower, the better) fell to 26.6% in the first nine months of 2007, from 31.2% a year earlier.

No U.S. exposure or liquidity problems

Fears over rising mortgage defaults in the U.S. cut Home Capital’s stock price to $30 in August 2007. However, the company has no exposure to the U.S., and the stock quickly recovered. Home Capital also has no direct exposure to any Canadian non-bank sponsored asset-backed commercial paper.

Home Capital probably earned $2.58 a share in 2007, and the stock trades at 14.7 times that figure. Earnings per share in 2008 should reach $3.19, which implies a p/e of just 11.9.

The company has raised its dividend in each of the past five years. The current annual rate of $0.44 a share yields 1.2%.

Still plenty of room to grow

Home Capital is facing rising competition in its market niche. But the market is still fragmented and there’s lots of room for growth. Home Capital also gets business from banks who refer clients they won’t service.

Home Capital Group is a buy.