April 26 (Bloomberg) -- Canada will prohibit banks from using insured mortgages to back their covered bonds while increasing oversight of the federal housing agency to cool off the country’s real-estate market.
Under rules in a budget bill that Finance Minister Jim Flaherty introduced in Parliament today, banks will only be able to use uninsured mortgages as collateral on covered bonds, which are notes usually backed by mortgages. The government will also strengthen oversight of Canada Mortgage & Housing Corp. through Canada’s banking regulator.
By barring banks from securing covered bonds with government-insured loans, Flaherty is discouraging mortgage lending by limiting cheap funding for home loans. The moves may raise borrowing costs for banks, leading to higher mortgage rates that would curb a housing market that has seen prices in some cities almost triple over the last decade.
“The government wants to be a little bit more restrictive in terms of slowing down the issues in the housing market and with consumer leverage more generally,” said David Tulk, chief Canada macroeconomic strategist at Toronto-Dominion Bank’s TD Securities unit.
Canadian lenders have been issuing covered bonds, which are backed by pools of residential mortgages, to fund their home-lending business. In most cases, the loans used to secure the bonds are insured by Canada Mortgage & Housing. The government currently guarantees the full value of home loans insured by CMHC and 90 percent of mortgages insured by private companies. The government will also set up a registry for companies that sell covered bonds.
“This is a superb long-term move for the development of the housing finance framework,” said Finn Poschmann, vice president of research at the Toronto-based research group C.D. Howe Institute. “As the market matures, we should find that the housing finance system can function perfectly well, out from under the umbrella of taxpayer guarantees.”
Under the legislation, lenders won’t be permitted to use mortgages insured by CMHC or private insurers such as Genworth MI Canada Inc. as collateral for the covered bonds.
Existing covered bonds will not be affected by the measures, according to the legislation. That means existing securities should benefit from greater investor demand than new ones because of the extra protection, said Francis Kestler, who trades covered bonds at Bank of Montreal in Chicago.
The price of Toronto-Dominion Bank’s 1.5 percent covered bond due 2017 rose, narrowing the spread to government debt four basis points to 68 basis points, according to data compiled by Bloomberg.
“The outstanding issues will be better bid,” Kestler said in a telephone interview. “I don’t think it kills the market” for new bonds, he said, adding “it will be more expensive for Canadian banks to fund themselves going forward using covered bonds.”
Banks that use insured mortgages as collateral “will launch new programs with uninsured mortgage pools,” said Andre-Philippe Hardy, a bank analyst with RBC Capital Markets in Toronto. The rule “would increase the funding cost on future new originations by an estimated 10-15 basis points,” Hardy said in a note to clients.
Of the C$1.2 trillion ($1.2 trillion) of mortgage loans made to Canadians, C$67 billion are insured mortgages that are pledged to covered bond pools, or about 5.6 percent of the total, according to data provided by Kevin Chiang of credit-rating company DBRS Ltd. Of the C$63 billion of outstanding covered bonds, C$54 billion or 85 percent are backed by insured mortgages.
Lisa Azzuolo, a spokeswoman for Genworth, declined to comment on the Canadian government’s plans on covered bonds.
The legislation also proposes that CMHC’s finances be checked at least once a year by the federal banking regulator to guard against excessive risk-taking.
“CMHC fully supports the measures,” spokesman Peter De Barros said by e-mail. “Enhancements to the governance and oversight framework for CMHC support the government’s continuous efforts to strengthen the housing finance system and Canada’s housing market.”
The Office of the Superintendent of Financial Institutions will study if CMHC is acting “with due regard to its exposure to loss,” according to the budget implementation bill. CMHC’s board of directors would also add two government deputy ministers under the legislation.
‘Important Financial Institution’
“I have been concerned about CMHC for some time in this sense: that it’s become an important financial institution in Canada and it wasn’t subject to the same supervision,” Flaherty told reporters in Ottawa. “This is an important step forward.”
The tightening of oversight over CMHC and changes to covered-bond rules will probably make it more difficult for borrowers “at the margins” of the market to qualify for mortgages, said Louis Gagnon, a professor of finance at Queen’s University in Kingston, Ontario.
“It will have the beneficial effect of preventing the most vulnerable borrowers from getting access to mortgages,” said Gagnon, a former senior risk-management official at Royal Bank of Canada. “So these people will have to wait longer to get into the game.”
To contact the editor responsible for this story: Chris Wellisz at email@example.com