Canada Targets Banks With Risk-Sharing Plan as Housing Booms

  • Finance department releases proposal for mortgage risk-sharing
  • Government proposes two programs where banks would pay more

Canada’s banks could see their costs rise by as much as 30 basis points under government proposals that would force them to take on a greater share of mortgage defaults, as policy makers seek to engineer a soft landing in the country’s housing market.

The estimates, contained in consultation documents released Friday by the country’s finance department, outline two ways banks could shoulder more of the burden from defaulted home loans in the country’s C$770 billion ($525 billion) insured mortgage market. In a “first loss” approach, lenders would be responsible for a fixed portion of an outstanding loan at the time of default. Under a “proportionate-loss" scenario, banks would pay a percentage of the total loan loss.

“Lender risk sharing would aim to rebalance risk in the housing finance system by requiring lenders to bear a modest portion of loan losses on any insured mortgage that defaults," officials wrote in the documents. The approach would maintain government backing on mortgages “to support financial stability in a severe stress scenario and borrower access to mortgage financing."

The government has been seeking ways to limit the impact on taxpayers of a potential housing correction. Friday’s proposal follows rules announced Oct. 3 by Finance Minister Bill Morneau, which imposed more stringent stress tests for borrowers and closed a tax loophole that benefited some foreigners when they sold a home.

‘Modest Level’

The impact of a “modest level of lender risk sharing is expected to have limited impacts on average lender costs,” according to the documents, which outline government proposals and launch discussions with the banking industry and public. Bank costs could increase 20 basis points to 30 basis points over a five year period of a risk-sharing program of 5 percent to 10 percent of the loan loss.

Still, the costs would vary under scenarios outlined by the government. Under a five percent first-loss approach and a C$300,000 mortgage, lenders would pay a maximum C$15,000, regardless of how big the loss is. Under a 15 percent proportionate-loss approach, the cost would be C$9,000 on a loan loss of C$60,000, C$15,000 on a loan loss of C$100,000 and $22,500 on a loan loss of C$150,000.

Setting aside more capital against defaulted mortgages would change a bank’s costs of originating an insured mortgage, which would affect supply and pricing, as well as mortgage insurance premiums, the finance department said. For lenders, capital requirements would rise with the expected loss. For mortgage insurers, loss and capital requirements would be lower.

“Because it’s changing the loss profile of insured mortgages then it must result in higher capital intensity of that product," Sohrab Movahedi, a banking analyst at BMO Capital Markets, said by phone from Toronto. “Absent any mitigating action on the part of the lenders, it weighs on the profitability of insured mortgages."

Fee Approach

The proposals under discussion could see insurers charge lenders a quarterly fee while continuing to shoulder 100 percent of a mortgage loss up front. The risk-sharing approach would apply to newly originated mortgages after the new policy is implemented.

Such an approach would preserve the current structure of insured lending and securitization, according to the documents. This includes preserving the full government backing of government-sponsored securitization programs, including National Housing Act mortgage-backed securities and Canada Mortgage Bonds, finance staff said.

Competition Changes

The government acknowledged that a shift of risk may change competition dynamics, with smaller and mono-line lenders -- those that do not take deposits and so have fewer funding sources -- less able than banks to absorb or pass on increased costs. Lenders more concentrated in one area could have higher loss exposure. The government suggested these lenders may hold more risk on their own balance sheets or sell insured mortgage at a higher price.

The Canadian Bankers Association, representing 59 domestic lenders and foreign bank subsidiaries, has taken a stand against risk sharing, arguing that Canadian mortgage defaults are so low that making lenders share the risk is unnecessary. Delinquency rates, those in arrears for 90 days or more, stand at 0.28 percent, or five times lower than those in the U.S., the CBA said.

Insurers and alternative lenders have also opposed the risk-sharing approach since at least last year, when finance department officials held meetings with them about introducing the proposal. They argue that not only are default rates low, all mortgages are underwritten by both the lender and insurer.

About 50 percent of C$1.4 trillion in home loans are insured. Canada Mortgage & Housing Corp., the nation’s taxpayer-backed housing agency and its largest mortgage insurer, has C$523 billion of insurance-in-force. It’s followed by Genworth MI Canada Inc., the No. 2 insurer with C$197 billion, and Canada Guaranty Mortgage Insurance Co. which holds C$54 billion in mortgage insurance. CMHC is 100 percent backed by the government in case of loan default, and its closely-held peers are 90 percent covered.

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