New Flaherty Rules Threaten Mortgage-Backed ABCP: Canada Credit

Photographer: Brett Gundlock/Bloomberg

The ratio of Canadian household debt to disposable income rose to a record 165 percent at the end of last year, Statistics Canada said last month. Close

The ratio of Canadian household debt to disposable income rose to a record 165 percent... Read More

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Photographer: Brett Gundlock/Bloomberg

The ratio of Canadian household debt to disposable income rose to a record 165 percent at the end of last year, Statistics Canada said last month.

A Canadian government move to limit housing risk may eliminate the C$6.8 billion ($6.7 billion) market for commercial paper backed by insured residential mortgages, according to DBRS Ltd.

The new policy, laid out in Finance Minister Jim Flaherty’s March 21 federal budget, will prevent mortgage-finance companies that don’t take deposits from funding home loans through asset- backed commercial paper, DBRS said in a research note this week. Sales in that part of the ABCP market rose from C$6 billion in December and now make up more than a quarter of the total C$25.6 billion outstanding, the Toronto-based rating company said.

Flaherty and Bank of Canada Governor Mark Carney have warned that mounting household debt poses a risk to the country’s financial system and economy. Financial institutions will be banned from using insured mortgages as collateral on securities not sponsored by Canada Mortgage & Housing Corp., the federal housing agency, the government said in the budget.

Lenders such as First National Financial Corp. (FN) and MCAP, both based in Toronto, are examples of companies that don’t take deposits, relying instead partly on asset-backed commercial paper to finance mortgage lending.

Such companies may not be able to offer as many mortgage products as commercial banks, curbing competition, DBRS analysts Kevin Chiang and Jamie Feehely wrote, and potentially leading to higher rates.

‘Too Much’

“Their balance sheets are quite small,” Chiang said yesterday in a telephone interview. “If they can’t find an outlet to fund these mortgages and they have to put them on their balance sheet, it’s just going to be way too much.”

Companies that offer ABCP may be unable to fill the gap with other assets, reducing the amount of debt outstanding, Chiang said.

First National has other ways of funding its mortgages, such as selling debt directly to institutional investors, Chief Financial Officer Robert Inglis said in an e-mail. Still, the alternatives may not be as “economical” as ABCP.

Less than 5 percent of the company’s C$67 billion of mortgages under management are funded through ABCP, he said.

A spokesman for MCAP didn’t return a call seeking comment.

The ratio of Canadian household debt to disposable income rose to a record 165 percent at the end of last year, Statistics Canada said last month.

Mortgage Rules

Flaherty tightened mortgage rules for the fourth time in four years in July on concern some regional housing markets were overheating. He reduced the maximum amortization period on mortgages the government insures to 25 years, from 30 years.

Canada requires that mortgages with down payments of less than 20 percent be insured. Most mortgages in the country are insured by CMHC and fully guaranteed by the government.

“The Government is making these changes to increase market discipline in residential lending and reduce taxpayer exposure to the housing sector,” said Stephanie Rubec, a finance department spokeswoman, by e-mail. “Financial institutions will continue to have access to a broad array of financing options.”

“The government will be consulting with industry stakeholders on implementation details and the timing of these measures,” Rubec said.

Elsewhere in credit markets, Calgary-based Pembina Pipeline Corp. (PPL) sold C$200 million in 4.75 percent 30-year securities priced to yield 235 basis points over comparable federal- government debt.

Corporate Bonds

The extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government debt held steady yesterday from a day earlier at 124 basis points, or 1.24 percentage points, according to Bank of America Merrill Lynch’s Canada Corporate Index. Yields increased to 2.72 percent, from 2.70 percent on April 24.

Spreads on provincial bonds were unchanged at 78 basis points yesterday from April 24, while yields rose to 2.48 percent, from 2.45 percent, according to the Bank of America Merrill Lynch Canadian Provincial & Municipal Index.

Corporate bonds have returned 2.2 percent this year, while provincial bonds have gained 1.1 percent and federal-government securities have added 0.9 percent, Bank of America Merrill Lynch index data show.

Two-year government bonds rose, sending the yield down one basis point to 0.93 percent. The price of the 1 percent bond due May 2015 added 2 cents to C$100.14.

‘Onerous’ Requirements

Flaherty last year prohibited insured mortgages from serving as collateral for covered bonds, another form of debt used by some banks to finance home loans. CMHC released detailed rules for issuers in December.

Lenders other than the country’s biggest banks are unlikely to issue covered bonds under the new system, because of “onerous” disclosure and compliance requirements, DBRS said.

The Canadian government is “wise” to limit its exposure to housing market losses, said William Aston-Reese, vice president of money-market sales at Tradition North America Inc. in New York.

“What happened here is the mortgages stopped performing, so the cash flow into the securities ended, and the commercial paper couldn’t be paid off,” Aston-Reese said by phone from New York. “Your exposure is to the entire housing market going belly up.”

Canadian existing home sales rose 2.4 percent in March from the previous month, the Canadian Real Estate Association said April 15. Sales were down 15.3 percent from a year earlier.

A segment of Canada’s commercial-paper market collapsed in August 2007 on concern that part of the debt was backed by risky U.S. subprime mortgages. More than 100 companies and 1,765 individuals were saddled with paper that couldn’t trade until a court-ordered plan to convert the short-term debt into longer- term notes was completed 17 months later.

To contact the reporter on this story: Andrew Mayeda in Ottawa at amayeda@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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