Canada Mortgage-Backed Securities Market May Cool on New Rulesby and
Housing measures from Morneau may curb origination of bonds
MBS sales have grown alongside Canada’s hot housing market
Efforts to cool Canadian home prices could trickle down to the C$440 billion ($335 billion) market for debt backed by insured residential mortgages.
Stricter rules for banks lending to home buyers and higher requirements for mortgage insurance could reduce mortgage origination in Canada and in turn lower sales of mortgage-backed securities, according to investors and analysts.
"If it slows down the housing market, it’s going to slow down the quantity of mortgages that will end up being on banks’ books, which means there’s a smaller pool that’s available to be securitized," Jean-Francois Pepin, co-chief investment officer at Addenda Capital Inc., which manages C$28 billion, said by phone. His Montreal-based firm invests in mortgage-backed securities.
Canadian Finance Minister Bill Morneau announced several measures Monday to curb the growth in housing prices, including higher insurance requirements on low-risk mortgages that are often pooled by lenders and packaged as traded securities.
Issuance of mortgage-backed securities in Canada has grown alongside the housing market as lenders look to offset the risk of mortgages and investors search for an asset class that offers a higher yield and strong credit profile. Total mortgage-backed securities outstanding under the government-guaranteed National Housing Act MBS program reached C$438.7 billion at June 30, up from C$424.2 billion for the same period the previous year, according to Canada Mortgage and Housing Corp. data.
Many mortgaged-backed securities in Canada are supported by government-insured mortgages, making them attractive to investors. Their appeal may even grow if issuance declines as a result of the new measures, Pepin said.
“If that leads to slower origination then current outstanding paper might actually increase in value because it’s going to be more difficult to get similar paper in the future," he said.
The rise in mortgage-backed debt comes amid growing concerns among government officials and the central bank that housing prices in Vancouver and Toronto have risen too quickly and consumer debt levels pose a threat to the Canadian economy. Measures introduced by Morneau will tighten access to mortgage insurance and require insured borrowers to stress-test their mortgages at higher rates, among other moves.
The changes will mean Canada’s banks have higher quality portfolios under their pooled mortgages, according to Jason Mercer, assistant vice president in the financial institutions group at Moody’s Investors Service.
"Going forward, only higher quality portfolios can be insured,” he said. “That’ll encourage stronger underwriting practices.”
The government also said it will begin public consultations on modifying the distribution of risk in housing finance by introducing “a modest level of lender risk sharing" for government-backed insured mortgages. National Bank Financial analyst Peter Routledge said in a Monday note that he expects the government to introduce any risk sharing initiative in a “very gradual manner" in light of current market dynamics.
Under Canadian law, home buyers who put down less than 20 percent of the cost of the home must insure the mortgage. Portfolio insurance, which allows lenders to insure mortgages that aren’t already backstopped by the housing agency, makes up about 35 percent of the mortgage insurance market in Canada. In its last quarterly financial report, CMHC said that portfolio insurance made up C$189 billion of its C$523 billion insurance-in-force.
The government’s housing agency said more than a year ago that banks need to take more responsibility for risk in the market. Canada Mortgage and Housing has already reduced the amount of portfolio insurance it provides to Canadian banks in a conscious effort to lower its exposure to Canada’s housing market, Mercer added.
"The vehicles we own at the moment are fully, irrevocably guaranteed by the government of Canada, so their yield is impacted by the level of liquidity in the market much more than by creditworthiness," Addenda’s Pepin said.