Canada Limits Banks from Using Insured Mortgages as Capital

Canada is reducing commercial banks’ ability to use insured mortgages as balance-sheet capital, according to budget documents released today.

The move, designed to limit risks to taxpayers from weakness in the housing market, aims to restrict the amount of so-called portfolio insurance -- government protection on mortgages with more than 20 percent equity -- that banks can hold on their balance sheets. The government is also seeking to ensure the insured loans flow into products securitized by Canada Mortgage & Housing Corp, the federal housing agency.

Since the 2008 financial crisis, some lenders have retained mortgages that carry the portfolio insurance on balance sheets to shore up capital ratios in accordance with international standards. Most mortgage insurance in Canada is provided by CMHC, which is backed by the federal government’s top credit rating.

“It means for the banks, those ways to fund themselves become a little bit more expensive,” said Michael Gregory, senior economist at Bank of Montreal’s BMO Capital Markets.

Under the changes, mortgages that carry portfolio insurance will eventually have to be securitized through CMHC, according to the text of a budget released today by Finance Minister Jim Flaherty in Ottawa. Canada will also ban insured mortgages, included those with less than 20 percent equity, from being securitized through anyone other than CMHC.

Canada requires that mortgages with downpayment of less than 20 percent be insured.

“These measures will restore taxpayer-backed portfolio insurance to its original purpose of allowing access to funding for mortgage assets,” the finance department said.

Insurance Limited

CMHC said last year it was limiting the amount of low-ratio mortgages it insures as it approached its legal limit of C$600 billion in insurance.

While the changes shouldn’t have a major impact on the ability of banks to finance mortgages, it reinforces the government’s recent efforts to limit the use of state-backed insurance, David Tulk, chief Canada macro strategist for TD Securities Inc., said in an interview.

“What they’re trying to do is push, very gradually, mortgage tail risk back onto the banks,” Peter Routledge, bank analyst at National Bank Financial, said in a telephone interview from Toronto. “To be honest, it’s not going make a difference this go-round, it’ll be our grandchildren’s credit crisis where the mortgage credit risk will be back on the banks’ balance sheets.”

Mounting Debt

The changes should have little effect on the housing market or CMHC’s issuance of bonds backed by mortgages, Routledge 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, which had its worst six-month performance since the end of the 2009 recession in the second half of 2012.

The ratio of Canadian household debt to disposable income rose to a record 165 percent last quarter, Statistics Canada said this month in Ottawa.

Canadian existing home sales fell in February from the previous month on drops in Vancouver and Toronto, the Canadian Real Estate Association said March 15. Sales dropped 15.8 percent from a year earlier and the average price fell 1 percent to C$368,895 on a non-seasonally adjusted basis, according to the report.

In an updated forecast released separately, the realtor group said sales will decline 2.9 percent on a yearly basis in 2013 to 441,500 units. The national average home price will drop 0.2 percent to C$362,600, it said.

‘Systemically Important’

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.

The government also said it will take steps to manage the risks of banks deemed “systemically important” by the country’s banking watchdog, the Office of the Superintendent of Financial Institutions. Such banks will face higher capital requirements, the department said.

In addition, the government confirmed systemically important banks will be required to hold some debt on their balance sheets that can be converted into capital if the banks fail, reducing the need for taxpayer-funded bailouts.

Flaherty said the government will extend the ability of Export Development Canada, which provides loans to exporters, to offer domestic loans until 2014. The government expanded EDC’s powers during the financial crisis to include domestic lending.

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