Canada’s big banks maintain they need to merge to grow to compete globally. But not so for three much smaller competitors. They are doing very well, thank you, by zeroing in on select local markets and specialized products and services.

Alternative credit provider .Home Capital Group Inc. . and project and equipment financing specialist .Pacific & Western Credit Corp. are niche players whose operations are heavily electronic, while .Canadian Western Bank .relies on high-quality service to compete with the Big Five for retail customers and small and medium-sized businesses.

All three are pursuing new opportunities, making them interesting possibilities for your own or your clients’ portfolios.

Edmonton-based CWB, for example, added a property and casualty direct insurer, .Canadian Direct Insurance Inc. ., last year and is starting a mortgage-origination business. Flush with cash, it’s looking for more acquisitions, such as a mortgage-origination business, a credit
union and/or books of financial assets.

Toronto-based Home Capital and PWC, the latter based in London, Ont., both have products they hope will be hits. For Home Capital, it’s a home-equity VISA credit card with a limit of up to $150,000 for small-business owners, professionals and individuals paying high interest on their outstanding balances. President and CEO Gerald Soloway says the service could eventually account for half of Home Capital’s earnings, vs the current 10%.

PWC is betting on its “continuous financing” program for receivables, which is aimed at large corporations, to produce dramatic growth. “We could do $1 billion for one customer,” says president and CEO David Taylor. As of April 30, PWC had $679 million in mortgages and loans outstanding.

> .The financials.

Of the three, Home Capital has had the strongest growth, with net income growing by 40% a year, on average, for the six years ended June 30. CWB, while showing strong growth, has not performed as well: for the six years ended April 30, its annual earnings have grown by 16.4%, on average.

Home Capital has also overtaken CWB on the bottom line, recording net income of $25.8 million in the first half ended June 30, vs CWB’s $24.4 million for the six months ended April 30. Furthermore, Home Capital had only about half as many assets as of the end of its second fiscal quarter, $2.9 billion vs $5.3 billion, and only 71% as much revenue ($63 million vs $88.4 million).

Home Capital reported earnings of $14.6 million in second quarter, up 37% from a year earlier. (CWB’s third quarter, ending July 31, won’t be out until the end of August.)
PWC is much smaller, with net income of $3.5 million and revenue of $9.1 million for
the six months ended April 30. Assets at the end of the period were about $1 billion.
PWC started as a trust in Saskatchewan but was forced to apply for a federal bank charter after changes to the province’s trust legislation made its business model no longer viable. The change caused losses in the second half of 2001 through 2002.

> .Canadian western bank.

CWB’s comparative advantage is regional flavour and level of service. At the retail level — it has 29 branches in the Western provinces — it has worked hard to build brand awareness, initiating a “Think Western” program in 2000, which, president and CEO Larry Pollock says, has been very successful and is continuing.
Brand awareness was helped by the 2004 purchase of Canadian Direct, which advertises the bank in its ads. The purchase was also, says Pollock: “A way to double the number of retail clients.”

Canadian Direct — which operates as a stand-alone subsidiary — is the largest private provider of home, auto and travel insurance in British Columbia, which accounted for 75% of its $41.4 million in gross written premiums in the first half. The insurer is expanding in Alberta, where the aim is to do an equal amount of business, and further expansion is planned. “We have thought about Ontario, when [the auto insurance market] settles down, and we can take it into Manitoba and Saskatchewan,” says Pollock. In anticipation, Canadian Direct has doubled the size of its call centre.

CWB is also looking to the mortgage-origination business for growth, and there is no doubt it is a hot sector. Mortgage brokers now account for 35% of annual originations, vs just 5% in 1998.

@page_break@And CWB isn’t the only new player. .Cervus Financial Group Inc. ., a start-up public company, already has more than $22 billion in commitments from mortgage brokers.
Competitors .Xceed Mortgage Corp. . and .FMF Capital Group Ltd. . both recently went public.

“CWB can carry at lot of mortgages on its books if we buy an originator,” Pollock says. “But it’s a lot less expensive for us to start our own business vs an acquisition, given the multiples at which companies in the business trade.”

It has been testing the market in the “B” (smaller) cities for a year and has started in the “A” (bigger) cities. It is getting A business from brokers and B business from a big chartered bank. “We now want size and are targeting $100 million in outstanding mortgages by September,” says Pollock. When CWB’s mortgage portfolio reaches $200 million-$300 million, it will initiate cross-selling.

CWB’s mortgage-origination business is already profitable because it uses the bank’s systems, branches and staff, hived off for the initiative. “Our competitive advantage is that we can provide a quicker answer in a number of locations,” says Pollock. Most mortgages require inspection and appraisal. In CWB’s case, “staff can drive by.”

On the commercial end, CWB offer small and medium-sized businesses an array of bank and trust services, which have expanded with the acquisition of .Valiant Trust Co. . last year.

CWB is also ramping up its industrial-equipment financing business — an area in which it may run up against PWC, which is now targeting investment-grade firms. “We had 20% growth in 2004 and are tracking faster in 2005,” says Pollock.

Growth in general commercial lending is also growing at 20%-plus.

While CWB, which started in 1984, had success with acquisitions throughout the late 1980s and the 1990s, its January 1998 purchase of Canadian Western Capital Ltd. and its efforts to develop a wealth-management business faltered. The subsidiary was sold to Vancouver-based .Goepel McDermid Inc. in February 2000.

> .Home capital group inc. .

Home Capital began in 1986 as an inactive energy company. In 1987, it started .Kingsway Financial Services Inc. . but sold the unit to its management team two years later in order to concentrate on alternative mortgages in Ontario through another subsidiary, Home Savings & Loan Corp. (now .Home Trust Co. ., with three branches in Ontario and others in Halifax, Calgary and Vancouver). The real estate collapse in the early 1990s made for hard slogging, but by 1995 Home Capital was well established. It has since reported continuous increases in quarterly profits.

The alternative mortgage market can be very profitable, as Home Capital has shown. The key is picking good risks (particularly young entrepreneurs, who don’t qualify at the banks), carefully monitoring and taking fast action when customers become delinquent.

Home Capital offers mortgages of up to 75% of the value of the property. Three-quarters of its $2.3-billion residential mortgage portfolio is in Ontario, with 10% each in of B.C. and Alberta and 5% in the Maritimes. Home Capital has looked at Quebec — “That could happen,” says Soloway. About 85%-90% of mortgages are renewed.

In 2000, Home Capital started securitizing mortgages for sale to other financial institutions, providing additional income and freeing capital. About 15%-20% of new mortgages are securitized, which amounted to $626 million as of June 30.

Also in 2000, Home Capital entered the alternative credit card market, providing cards to customers who don’t qualify at the big banks. The cards are either secured by a customer deposit or have very low credit limits. It’s a profitable niche but not a big growth area, as customers move to regular cards once they have re-established their credit rating.

The home-equity VISA, on the other hand, offers huge potential. Customers register a collateral mortgage as additional security. Interest charges are much lower, 7.99%-13.99%, depending on income and creditworthiness, vs 17%-19% for most other cards.

The company has issued 2,500 cards, which had $71.2 million in outstanding balances as of June 30. Home Capital is now broadening its marketing, targeting the mortgage brokerage network. “We could see another year of big growth in 2006 if we get the marketing right,” says Soloway.

Home Capital will be ready. In the past year, it has doubled credit card division staff.
“When we anticipate growth, we hire and train well in advance of marketing,” he says.
Most Home Capital employees are shareholders. Under the employee ownership plan, up to 10% of an employee’s annual income can be used to purchase shares, with the company adding 50¢ for every $1 from the employee. Shares vest immediately. About half of employees who have been with the company a year or longer are shareholders. Soloway owns 9% of the 33.8 million shares outstanding.

Home Capital got rid of its multiple-voting shares in 2003 with a straight share exchange. “We had a long-standing commitment to shareholders that we would not perpetuate one group in power,” Soloway says. This eliminated the discount at which shares tend to trade when there are multiple-voting shares.

> .Pacific & western credit corp. .

PWC, which started in 1970 as a traditional trust company, changed direction in 1993 when Taylor acquired a controlling interest and initiated the current business model.
PWC expects to double its assets in five years but could grow much faster if its continuous receivables-financing product — currently $1 billion in assets — takes off.
The economies of scale are already there, says Taylor: “If we get to $5 billion in assets, our ratios would be untouchable.”

PWC’s return on equity is running at 15.5% but is depressed by the drawing down of its deferred tax asset, built up when the company was reporting losses. Excluding this, ROE is around 23%. Fixed costs as a percentage of average assets is 0.95, vs the industry average of 2.4. Assets per employee are $25 million and, while that might drop to $20 million, it is still way above the $5 million-$6 million average for the industry, says Taylor.

PWC’s main business, project and equipment financing to public-sector entities, is seeing strong growth. It’s expanding the equipment financing to investment-grade companies, which is a slow process. “We have to develop awareness that we are in this market,” says Taylor. The market is also competitive, and other companies will drop their prices to compete. So far, PWC has booked about $60 million in leases, and Taylor sees that reaching $160 million in a year. PWC is also aggressively pursuing new vendors for more point-of-sale equipment financing business.

However, it is the receivables-financing product for large firms that could hit the home run. After a successful pilot project, it now has to persuade companies to try it. “We’re facing normal resistance,” says Taylor. PWC has one small customer and is optimistic the large company with which it did the pilot will sign on. Firms may start with part of their receivables both to test the program out and provide an alternative source of financing.

With the receivables-financing product, PWC’s computer system talks to a customer’s system, allowing PWC to finance receivables each day with money raised through its deposit broker network. Pricing is done individually and, says Taylor, “[Clients] would probably collect for us so they retain the customer relationship.”

The advantages: “Very competitive interest charges and no debt time,” Taylor says. There are no commissions and less legal work than the alternative of securitizing.

Once PWC lands a big client, it will look for an investment-grade debt rating in order to raise capital.IE