End of Canada’s ‘Unique’ Mortgage System Means Higher Bank CostsBy
Canada to begin consultations as part of housing measures
‘We continue to believe that this could have profound impacts’
The days when Canada’s banks could offload much of the risk of underwriting mortgages onto taxpayers may be drawing to a close.
Canadian Finance Minister Bill Morneau disclosed plans Monday to begin consultations on sharing the risk of mortgage default with the country’s lenders. The move was part of a package of measures designed to stabilize the housing market after years of soaring prices in Vancouver and Toronto.
While it’s not clear what form that risk-sharing will take -- a deductible on mortgage insurance may be one option -- any move will likely require Canadian banks to boost capital levels and result in higher mortgage rates, according to analysts. The banks’ industry group, which includes Royal Bank of Canada and Toronto-Dominion Bank, is already fighting back.
“This could have profound impacts on the insured mortgage funding market and the equity market’s perception of credit risk in the banking sector,” Jason Bilodeau, an analyst with Macquarie Capital Markets, said in an Oct. 4 note to clients.
One reason Canada’s banking industry has been cited as one of the world’s most stable is that the government backs all the mortgage insurance obligations in the market. That includes fully-backing mortgage insurance sold by Canada Mortgage & Housing Corp. and 90 percent when sold by private insurers like Genworth MI Canada Inc. that compete with the government agency. This iron-clad government support on insured mortgages is “unique” in the world, according to the finance department.
More than half of Canada’s C$1.4 trillion home loan market is made up of insured mortgages, according to figures from the Bank of Canada and finance department. Home owners are required to take out insurance if their down payment is less than 20 percent of the house value, though banks often buy so-called portfolio insurance even when the down payment exceeds that level.
As household debt levels swelled amid housing booms in Vancouver and Toronto, groups including the Organization of Economic Co-operation and Development, CMHC and the even the department of finance have called for lower risks to taxpayers.
A switch to risk-sharing “would require mortgage lenders to manage a portion of loan losses on insured mortgages that default, rather than transferring virtually all the risk onto the taxpayer via the government guarantee for mortgage insurers,” Morneau told reporters Monday in Toronto.
Risk sharing could disrupt mortgage lenders’ funding strategy on securitized funding programs such as the National Housing Act Mortgage Backed Securities and Canada Mortgage Bonds as well as unsecured funding, National Bank Financial analyst Peter Routledge said Monday in a note.
“Ultimately, any form of risk sharing will put upwards pressure on mortgage rates as lenders will need to set aside higher levels of capital for NHA MBS and CMB funding and/or the cost of that capital is adjusted upward to reflect a potentially higher-risk balance sheet," Routledge said.
Risk sharing may reduce lenders’ ability to fund their balance sheet in a low-cost and efficient fashion and crimp their efforts to sell pooled mortgages for securitization, he said.
Canada Mortgage & Housing, the country’s federal housing agency that provides insurance for home loans and oversees mortgage securitization programs, welcomed tougher housing market regulations.
“Lenders have, as I’ve said in the past, no skin in the game, and therefore the incentives are misaligned with good risk management," President Evan Siddall said Tuesday during a CMHC conference in Ottawa.
Such risk sharing changes could hurt Canada’s housing finance system, according to the Canadian Bankers Association, which represents the nation’s industry.
“The introduction of lender risk sharing through a deductible on mortgage insurance would represent a significant structural change to the current housing finance system," the association said in a Monday statement. "We have concerns that it could have negative side effects on a housing finance system that has worked smoothly, simply and efficiently and served Canada’s economy well."
Mortgage lenders such as Equitable Group Inc., Home Capital Group Inc., First National, MCAN Mortgage Corp., and Street Capital Group Inc. will have more difficulty than Canada’s six-biggest banks in absorbing the associated costs because they have less earnings diversity, Routledge said.
Mortgage stocks tumbled in Toronto Tuesday in response to the measures. Genworth MI Canada Inc., Canada’s biggest private mortgage insurer, fell 10 percent to C$30.64 and alternative lenders such as First National Financial Corp. also dropped. The eight-company S&P/TSX Commercial Banks Index was down 0.4 percent.
"We expect the government to approach any such risk-sharing model in a very gradual manner," Routledge said. "The need to avoid unintended negative consequences remains paramount for Canadian banks and mortgage companies, which rely on a well-functioning, government-backed MBS market."
While the government backs 100 percent of the mortgage insurance obligations of CMHC, it also supports private insurers -- Genworth and Canada Guaranty Mortgage Insurance Co. -- subject to a deductible equal to 10 percent of the loan.