Name: Robert McLister

Email: robert@canadianmortgagetrends.com

Biographical Info: Robert McLister is one of Canada’s best-known mortgage experts, a mortgage columnist for The Globe and Mail, editor of CanadianMortgageTrends.com (CMT) and founder of intelliMortgage Inc. and RateSpy.com. Robert created CMT in 2006. The publication now attracts 550,000+ annual readers, is a four-time Canadian Mortgage Awards recipient and has been named one of Canada’s best personal finance sites by the Globe & Mail. Prior to entering the mortgage world, Robert was an equities trader for eleven years and a finance graduate from the University of Michigan Business School. Robert appears regularly in the media for mortgage-related commentary (recent coverage: http://bit.ly/tUjp3Q). He can be followed on Twitter at @CdnMortgageNews


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Canada’s largest public non-bank lenders have wrapped up their first quarters. Among other trends, two big themes this quarter were the tightening of mortgage spreads and a refocus on improving customer retention. 

To get colour on those and more, we combed through the transcripts of three non-bank giants, First National, Home Capital and Street Capital. Here are the highlights…


Street Capital

Notables from its call (Source):

  • Street now has over $25 billion in mortgages under administration.
  • $1.52 billion worth of mortgages was sold during the quarter compared to $1.62 billion the year before.
  • CEO Ed Gettings said that Street’s first objective is to advance its Schedule 1 bank application through to completion. It has been strengthening its capital position as part of that process. “We expect to be in a position to operate as a Schedule 1 bank in 2017,” Getting said.
  • “Our second objective is to continue to grow mortgages under administration and hold steady our market share in the mortgage broker channel,” he added. “Our share dipped in Q1 to 7.6% as our underwriters adjusted to some of the changes we put in place during the quarter in preparation to become a Schedule 1 bank.”
  • Gettings said Street is currently ranked 6th in market share in the mortgage broker channel. “We are targeting to regain the number three or number four position in this channel.”
  • Looking ahead to 2017, Getting said Street is looking to generate “solid earnings growth” as loans underwritten over the past three years come up for renewal. “We sold 62% more mortgages in 2012 compared to 2011 and that is why we are so confident that 2017 will be a solid year for renewals.”
  • The gain on sale percentage (as a percentage of mortgages sold) was 177 basis points in the quarter, lower than the 192 basis points last year. “The decline was due to tighter spreads in Q1 of this year compared to the unusually high levels of last year,” said CFO Marissa Lauder. “We expect on a full-year basis that the gain on sale percentage will normalize in the range of 178 basis points to 182 basis points.” (178-182 bps would translate to $1,780-$1,820 gross revenue on a $100,000 mortgage.)
  • Renewals accounted for 21.7% of loan sales in the current quarter versus 18.5% in Q1 2015.
  • “…assuming the company launches the bank in late 2016, we are estimating that the bank activities could add approximately 2% to 5% to revenue in 2017 and 10% and 20% in 2018 when compared to 2015 revenue,” Lauder said.
  • Street Capital President Lazaro DaRocha provided this update on the company’s bank application progress: “…OSFI observations had required some adjustment to our underwriting process to align with new industry-wide changes. As at the end of February, we had completed all of the required changes. We now expect that OSFI will be conducting a follow-up onsite review to validate these changes in this summer. This timing supports our expectation of receiving approval in 2016. We fully expect to receive approval to operate as a Schedule 1 bank in fiscal 2016. However we have not built any meaningful contribution of profitability into our expectations until 2017.”
  • “…We’ve seen our Alberta volume, which was about two years ago probably in the range of 22% to 25% of total originations, has dropped down to roughly about 15% of total originations,” said DaRocha. “And that has happened through a combination of things. One, the market in itself out there (is) slowing down, but two, we proactively tightened up there, probably…a year and a half to two years ago.”

 

Home Capital

HCG-LOGONotables from its call (Source):

  • Total originations in the quarter were $1.78 billion, an increase of almost 29% from the last year’s $1.38 billion.
  • Net non-performing loans as a percentage of gross loans was 0.34%, compared to 0.25% of the end of Q1 2015.
  • “I am going to state categorically, Home Trust has no exposure to Urban Corporation,” said outgoing CEO Gerald Soloway. “We continue to observe strong credit profile and stable loan-to-value ratios across the portfolio, which continues to support low delinquency, a low non-performing rate and ultimately the key low net write-offs. In fact, net write-offs were $1.6 million in the quarter representing 0.04% of gross loans…”
  • On the topic of new technologies, current President and incoming CEO Martin Reid talked about Home Capital’s new broker portal, Loft. “Brokers can get time-stamped documents, real-time updates on the status of deals and the attributes of those deals. We’ve completed [the] pilot…We’ll continue to roll out Loft and should have it substantially rolled out by the end of the summer to all of our broker partners.”
  • Asked what makes the program different from others already on the market, Pino Decina, EVP, Residential Mortgage Lending, said this: “(It’s) literally end-to-end, so throughout the entire origination process of a mortgage, a broker can see exactly, as Martin mentioned, what the status is of their new application, of their pending mortgage, outstanding commitments all the way through the funding, so that sort of makes ours different from anything else in the marketplace.”
  • Martin also commented on Spire, a broker loyalty program that launched on April 1. “This is designed to reward brokers who bring us business but it’s much more than that; it rewards brokers who bring us the right kind of business.”
  • “…in 2015, an area of weakness that we identified was in retention of customers looking for early renewal,” said Reid. “This was part of why, despite growth in originations, our portfolio shrinks. We’ve added resources to our retention team with the focus on retaining these customers with increased originations and retaining more of our existing clients, we should start to see the overall portfolio growing quite nicely.”
  • Regarding the additional resources being dedicated to Home’s retention team, Decina said: “…the resources that we’ve allocated … are going to be more experienced underwriters or originators. So individuals that…do call in, looking for either mortgage statements or discharge request of their mortgages, obviously we know they are shopping somewhere else or they are looking to refinance somewhere else. They will be able to walk through with some sort of [idea] what they are looking for, find other opportunities, other products and ways to keep them here at Home. So that’s a first strategy. The second is actually built within our Spire partnership program. And really as we onboard brokers onto the program, it’s not only about what they are giving us on a monthly basis and new origination, there is a component built within Spire which rewards brokers for keeping clients here long term.”
  • Decina confirmed a portion of the increased expenses is going towards broker commissions.
  • Asked about the price increases in the GTA and Vancouver, and whether Home is seeing any of its traditional clientele being priced out of the market, Soloway responded: “People are still affording reluctantly. They can afford the houses … and we haven’t really seen any difference in credit quality. If anything, the credit quality sort of upticks year-over-year when we do all the analysis. As funny as it sounds, people are basically coming with larger down payments and better Beacon scores.”
  • Asked about the narrowing net interest margin, and whether Home is seeing competitive pressure on the pricing side, Soloway said, “the mortgage market remains quite competitive especially at the high credit quality end of the business. There has been a little tightening of spreads, but we’ve also been able to do acquisition funds that were a little more reasonable. We’ve found that our funds that we raised directly are cheaper on the whole than what we raised through the broker portal.”
  • Reid said the company is about 75% through the verification process of mortgages that were handled by brokers cut off from Home Capital. “What we are finding is that out of that portfolio, less than 10% we would not be willing to renew.”

First National

First-National.gifNotables from its call (Source):

  • Mortgages Under Administration increased 8% year over year to $94.3 billion, a new record, driven higher by strength in mortgage origination and renewal retention.
  • Originations in the quarter amounted to $2.9 billion, also an 8% increase over last year.
  • “…originations increased in spite of an obvious decline in mortgage activity in Alberta,” said CEO Stephen Smith. “As we’ve discussed on recent calls, volumes in our Calgary office have declined in the face of the oil industry’s downturn and higher unemployment. This quarter, First National’s single-family originations were down in the region by 10% over last year. We expect weak activity in oil patch communities to continue.”
  • “…the single-family team made up for this with higher originations in other areas of Canada such that total single-family originations were 3% higher than a year ago at just about $2 billion,” Smith noted. “First-quarter single-family renewals were higher than a year ago as well, up 28% on a good volume of renewal opportunities.”
  • Mortgage investment income was 5% or about $700,000 lower than a year ago, reflecting a provision for loan losses. “Lower mortgage rates also affected the amount of interest earned on mortgages warehoused prior to securitization,” noted Chief Financial Officer Rob Inglis. “In last year’s first quarter, 5-year mortgage rates were about 3.09% compared to 2.79% to start 2016.”
  • “From a market perspective, we think 2016 will be somewhat similar to 2015 with strength in most regional markets, save for Alberta and Saskatchewan,” said Executive Vice President Moray Tawse.
  • “The Alberta market downturn also elevates the risk of credit losses, but as we’ve noted previously – and as our long-term results show – First National does not have the same exposure as other financial institutions because our securitized mortgage portfolio is almost 100% insured and the uninsured MUA is on the balance sheets of our institutional customers,” Tawse said.
  • “First National has significant mortgage renewals coming up this year and we started to take care of this opportunity in the first quarter and we will continue to do so going forward,” Tawse added.
  • Asked about arrears for the quarter, Rob Inglis said: “…we haven’t seen a deterioration in arrears numbers with respect to Q4 numbers nor have we seen a deterioration in arrears numbers in Alberta or Saskatchewan.”
  • Asked about mortgage spreads in quarter, Smith said: “Earlier in the quarter we had some good opportunities. To some extent what we’re benefiting from here on the spreads is the fact that we took the fair market loss in the first quarter of last year and that starts to manifest itself in wider spreads for this year, so that would be one factor. I think actually spreads were fairly good in the fourth quarter and then in the first quarter, so that’s another good factor. Actually as we speak, I think spreads are quite tight. We’ve had a backup in the bond market in the last week or so, so we think we’ve seen spreads tightening. I think that will correct but, you know, it could remain tight for a while so predicting where spreads will go is always a little bit of an issue.”
  • On the topic of discipline among competitors, Smith noted: “every spring we see competitors not being particularly disciplined, just generally there always seems to be a bit of push for market share. I think (because of) the recent rule changes where aggregators now have their own NHA-MBS allocation. This provided a degree of liquidity to the market that put some pressure on spreads in the broker space, [where] monolines participate. I think we might see tighter spreads there.”

Note: Transcripts are provided as-is from the companies and/or third-party source, and their accuracy cannot be 100% assured.

Steve Huebl & Robert McLister


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Old way-new way FB A recent Scotiabank survey reinforced what most of us already know: the Internet is radically changing banking.

The bank found that:

  • 96% of Canadians rely on the Internet for information.
  • 89% of Canadians say it’s easier to get info online than through other sources.

In turn, by 2020 less than 1 in 10 financial transactions will occur in branches, predicts Scotiabank CEO Brian Porter. “At the same time, we expect sales through digital channels to increase materially – likely in excess of 50% of total products sold,” he told the Financial Post.

That’s exactly why the company has invested billions in fintech, including a new technology “factory” in Toronto, which will house 350 new online engineers and designers. There, it hopes to spit out brand new web tech that will do things like simplify the mortgage application process (which its “Rapid Lab” team is already piloting at certain Scotiabank branches).

“We’re moving from a paper-based approach to a more technology-enabled, digitized approach,” a spokesperson told Reuters.  (We can only hope that includes e-Signing, something customers love for its convenience.)

All of this is shifting employment at the bank. While Scotiabank is ramping up mortgage tech jobs, it announced job cuts to its adjudication centres and mortgage operations last fall. There’s no better glimpse of human resource efficiency than at its Tangerine subsidiary. Tangerine serves two million customers with just 1,000 employees (compared to 23 million with more than 89,000 employees at Scotiabank).

Tailored Pricing

Half of those who use the net for research feel overwhelmed by the amount of data it presents. So it’s no surprise that 70% of Canadians still rely on advisors for mortgage advice. Seventy per cent is a lot but it used to be closer to 100%, so times are changing and Scotiabank knows it.

With consumers comparing rates online, pricing is more of a factor than ever. That’s partly why Scotiabank has quietly joined the low-frills mortgage movement. Its new “Value Mortgage” follows the lead of BMO, which has had a stripped-down mortgage since 2010.

Compared to Scotiabank’s regular mortgage, the Value Mortgage has:

  • A rate that’s roughly 10-15 basis points lower
  • 10% lump-sum prepayments instead of 15%+
  • Once-a-year lump-sum prepayments or payment increase instead of the ability to make them anytime
  • An annual 10% payment increase option instead of 15% plus double-up
  • 90-day rate holds instead of 120 days
  • STEP product not available
  • No porting

The Value Mortgage has no refinance restrictions, which is a big plus compared with BMO’s “Smart Rate” mortgage, but the lack of portability could be a major turn-off. It requires borrowers to potentially pay a penalty in order to move their mortgage to a new property. Albeit Janet Boyle, Vice President, Real Estate Secured Lending assures, “We will work with customers up front to ensure they are selecting the term that is right for them and fits with their future plans.”

Scotiabank’s low-frills pricing is currently only available in branches. When asked if the product will be available to brokers, who account for roughly 40% of Scotiabank’s volume, Boyle said there are no such plans “in the immediate future.” That’s largely because brokers already have access to deeper rate buydowns than branch reps.

Scotiabank-Logo-PNG-03791-1Encouraging Conversations

Scotiabank now offers three brands of mortgages:

  1. The “Value Mortgage”
  2. The “Flexible Mortgage” (Scotiabank’s regular mortgage)
  3. The “Rewards Mortgage” (which comes with an annual cash reward and Scotia Rewards® Points)

This isn’t by accident. The bank intentionally wanted to create more customized mortgage options.

“We did a lot of behavioural research on what customers want to pay for,” says Boyle, who acknowledges that the Value Mortgage “appeals to a very small segment of borrowers.”

“The approach of having three mortgage solutions has really worked well for us on a national basis,” she says. “Customers like to research on the Internet but they prefer to sit in front of a person,” and having different options lets Scotiabank bankers strike up a dialog about what needs and goals are important to clients.

As for pricing, the bank is constantly investing more in data analytics to better understand its customers. Ultimately, says Boyle, “The customer profile and their relationship with the bank determines the rate.”

 

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Handshake 2 FBWhen it comes to mortgage origination volume, the most successful brokerage operation in Canada—hands down—is Dominion Lending Centres (DLC). In 10 years the company has gone from zero to 5,000+ agents, 650 locations and more than 40% market share in the broker space.

FCF Capital Inc. (FCF) saw that success and decided it wanted a piece of it. So it bought 60% of DLC for almost $74 million. That pegs the entire enterprise value of the company, if you include assumed debt, at roughly $139 million according to co-founder Gary Mauris.

We spoke with Gary and FCF CEO Stephen Reid this morning. Here’s the nitty gritty…

Purchase Specifics

  • DLC shareholders get $61+ million cash plus $12.5 million in stock. The stock has a 4-month lockup. (Source)
  • FCF says it paid a multiple of 8.4 times short-term EBITDA (earnings before interest, taxes, depreciation and amortization). 
  • DLC’s 2015 net earnings were $6.8 million (This does not include the millions agents pay into DLC’s advertising fund, of which 88% is spent directly on advertising and 12% goes to administrative expenses, like figuring out where/how to advertise.)
  • Based on DLC’s 2015 revenue of $26.9 million, the multiple FCF paid is about 2.75 times.
  • FCF did a capital raise three weeks ago to generate part of the capital it used for DLC, including investments from at least eight “billionaire families.”
  • The deal did not include DLC’s budding insurance arm. “…We didn’t want to haggle about a business that hasn’t ramped up yet,” says Reid.
  • The parties hope to close by June 30, 2016, or July 29, 2016 at the latest, subject to various approvals including that of shareholders and the TSX Venture Exchange (where FCF is listed).

Who runs the show?

  • DLC will have a new board consisting of co-founders Gary Mauris and Chris Kayat, plus Stephen Reid and two other FCF nominees.
  • “…We put money in passively and have no management rights, nor do we want any,” says Reid. “…We can’t force a sale, nor do we want to.”
  • If push came to shove, “We can make (operational) changes if we need to…but I don’t know what we have to contribute,” says Reid, who notes that FCF is investing millions in DLC because it’s already well managed.
  • Reid acknowledged that certain management can be replaced if they don’t hit targets.
  • “…We’ll always take 25-50% of the upside and contractually give it to the other side forever…We make more money by giving more…The management team wins first and we win second, and that’s how we’ve always invested,” Reid says.

DLC mergerWhy did Mauris and Kayat want to sell?

  • “There’s only so much you can do with a small number of partners,” Mauris said, which prompted the company to explore bringing in capital sources. “We started reaching out to bankers to find a combination where we still own it and control it, but have new capital to grow. We wanted a passive long term partner in the business.”
  • And then, there’s the personal side. “I’m 47 years old and I’ve been on an airplane 130 days a year. It was time to de-risk a little bit.” But Mauris is careful to stress, “This is a long-term play for us…I’m not going anywhere.”
  • “We’ve had 13-14 companies who wanted to buy us outright or partner with us. These guys (FCF) didn’t buy it to run it.”
  • DLC’s founders have a big carrot to increase earnings. It’s called an inverted revenue share. They get to pocket 40% of the first $14.6 million paid annually to shareholders, but get to keep 70% of anything above that.

Why Did FCF Want DLC?

  • “We like the franchise industry and DLC is a 10 out of 10 in every single category,” Reid told CMT. “It has impeccable financials, great leadership, terrific partnerships and 650 franchisees, each of whom is a real business with a real owner who says, ‘I’m going to make my business work’.”
  • Unlike a normal venture capital firm that wants an exit (sale) in 5-7 years, FCF is in it for long-term cashflow. Its #1 objective is to pay out a low-risk, long-term yield to its investors, and it thinks DLC can spin off good cash to make that happen.

What’s Next for DLC?

  • “…We have owned up to invest more money for [DLC’s] targets and initiatives,” states Reid, who is enthused about further geographic growth in Canada and more ancillary offerings that could appeal to borrowers at the point of sale, like insurance, home inspections, etc. Even the U.S. “is being considered” as another growth avenue for DLC, he adds.
  • With FCF’s vast network of resources and M&A contacts, it will assist DLC in acquiring strategic targets, including more brokerages. “We’ll continue to buy competitors. If there are well-run broker networks who want to take money off the table, we’re a buyer,” says Mauris.
  • FCF plans to move to the TSX Exchange later this year, which will improve its (and DLC’s) access to capital.
  • “We have no plans to become a lender for the foreseable future,” says Mauris. “We have learned over the years the value of having close relationships with a range of lenders.” (“We still have a position in Canadiana,” he adds.)
  • Mauris still sees lots of organic growth potential in Canada and it’s largely a function of consumer awareness. “The value that brokers give to consumers is growing because consumers are starting to understand it.”
  • Client communication is also a growth opportunity. DLC is focusing on improving “touch points” with customers to keep its brokers top of mind. “Banks are staying in touch with their customers…[but] only 10% of brokers do it consistently,” Mauris says.
  • The broker industry is also quite fragmented, Kayat says. There is power in numbers and strength in joining forces. “When you look at the banks’ advertising budgets…there is hundreds of millions of dollars of ad spend every year. consumers get bombarded by bank marketing. It is hard [for individual brokers] to educate consumers about their value.”
  • Mauris says DLC has two other initiatives on the go, including “significant tech builds” currently underway. “We’re also going to get more involved in rate sites.”
  • When asked if he believes overall broker market share (currently about a third of the market) will ever exceed 50% in Canada, Mauris was quick to answer: “I absolutely do…We’re on our way,” he said, noting that 55% of first-time buyers use brokers already.

What are the risks?

  • “We don’t see many,” says Reid, who acknowledges potential risk in a housing slowdown and declining broker margins.
  • As for the Internet’s negative impact on margins, Reid says, “…Not only could it happen, it will happen…everyone wants to go on the web and get instant access to information. We all want efficiency. Shopping for a mortgage on my own [on the Internet] will erode the business somewhat,” but he’s confident DLC’s entrepreneurial ability will overcome that. “Some people like fast food and some people like a steak dinner…There are all kinds of different models [that can succeed],” including in the brokerage business.
  • Rate sites are a factor, but Mauris believes strongly in the value of human professional advice. “When you have a product like mortgages that must be tailor fit…one size does not fit all.” He says add-on products will offset shrinking broker margins and notes that rate competition doesn’t necessarily have to drive down agent commissions on a 1-for-1 basis.

Our take

This deal puts competing broker networks on alert. Their #1 competitor has just become all the more powerful. In a business where volume and scale increasingly matter, smaller players will have to carefully assess their long-term growth prospects. Some will undoubtedly choose to not take a risk with their future valuations and merge, be that with other firms or with DLC.

One thing’s for sure. Success breed success. The company is making plays that are making its agent stronger and more recognized by the public. Once DLC pierces 50% market share (which is a matter of time in our view), it could be a psychological tipping point in the industry. Not only will it have serious bargaining power with suppliers, further internal economies of scale and more revenue to reinvest in its business, but DLC Group’s ability to recruit agents attracted by its technology, rate buying power and marketing could reach another level.

“The next 5 years should be our best 5 years,” Mauris says. With the clout of his newfound partner, that could very well be.


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As we like to say around here, it’s good to be a bank. Reason #188 (or whatever number we’re up to now) is covered bonds. Only seven lenders in Canada can issue covered bonds, and six of them are major banks.

Who should care about covered bonds?

Any mortgagor with at least 20% down who prefers a lower rate.

Covered bonds (CBs) are a low-cost way to raise mortgage capital, which the lender (issuer) can then lend out to borrowers. Essentially, CBs are just packaged up pools of uninsured mortgages that mega-lenders sell off to investors.

Investors like CBs because:

  • the bonds are “covered” (backed) not only by the mortgages, but with the full faith and credit of the lender itself
  • the mortgage collateral is segregated in case the bank ever goes belly up
  • the bonds are over-collateralized by about 5-10% (i.e., issuers back them with more mortgages than necessary)
  • all mortgages have at least 20% equity, resulting in small default rates
  • mortgages are generally removed from the cover pool if they’re over two months delinquent (and almost certainly if 90-days+ delinquent, due to the asset coverage test issuers must meet)
  • investors can rely on Canada’s solid CB legal framework
  • CBs are rated AAA, the highest rating possible (in fact, Fitch’s triple-A rating even factors in the risk of a 25% plunge in home prices)

All of this makes covered bonds a tasty treat to yield hungry high-quality bond investors.

Covereds

Demand is off the charts in Europe, where (get this) our banks are issuing CBs at just a fraction above 0%! That’s possible because CBs are relative bargains versus European bonds, which yield near/below 0%. Bloomberg calls it a “covered bond boom,” citing a 37% ($7.2 billion) increase in Canadian issuance versus last year—a record pace.

CB sales would be even higher were it not for regulators preventing banks from issuing more than 4% of their assets in covereds. Banking regulator OSFI’s covered bond issuance limit is “extremely low compared to other developed nations,” says C.D. Howe housing watchdog Finn Poschmann. In most advanced countries there is either no limit at all, or it’s much higher (e.g., 8-10%).

Raising Canada’s 4% cap needs to be an OSFI priority. With all the regulation Ottawa has thrown at banks since the credit crisis, hiking the issuance limit is a safe way for policy-makers to loosen the noose. Doing so would pose no appreciable risk to taxpayers (the government doesn’t guarantee CBs like it does Canada Mortgage Bonds and mortgage-backed-securities). Moreover, while risk to bank depositors would theoretically increase (since CBs can’t be liquidated for depositors in a bank insolvency), a slight deposit insurance hike could offset that risk.

The benefits to borrowers would be measurable. Banks would have more international liquidity for their mortgages, which could directly result in lower interest costs and less pressure on banks to boost fees.

Granted, this idea may be a political hot potato at the moment. Daily headlines on housing overvaluation won’t make raising CB limits OSFI’s top priority. But regulators do a lot of taking, and sometimes they have to give a little too. A CB issuance policy that’s closer to international standards would be a net win for families slaving to pay their mortgage. To the extent the limit can be safely increased, policy-makers should help Canadians keep more money in their pockets.

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Rising rates3Non-bank lenders rely heavily on securitization (selling mortgages to investors to raise money). They then lend that money out to new borrowers. This July, that’s about to get a whole lot more complicated…and costly.

Big changes are afoot in the mortgage business, and they’re coming to a lender near you in two months. They include:

  • Higher fees for lenders who use government-guaranteed mortgage-backed securities (MBS)
  • Restrictions on securitizing mortgages in non-CMHC guaranteed securities
  • A requirement to securitize portfolio (bulk) insured mortgages within six months

New Guarantee Fees

The Department of Finance (DoF) wants to spur development of “private market funding sources” for mortgages. The goal is to reduce Ottawa’s direct exposure to mortgage risk. CMHC’s answer is to raise the cost of government-sponsored funding. The losers here are lenders that depend on securitization methods, like the Canada Mortgage Bond (CMB). These extra fees will likely be passed straight through to consumers in the form of higher rates.

Banning Non-CMHC-Sponsored Securitization

Effective July 1, lenders will no longer be able to directly place insured mortgages in non-CMHC approved securities. Lenders who rely on asset-backed commercial paper (ABCP), which include a few of the top non-bank broker-channel lenders, will have to find another way to sell their mortgages.

That’s a problem for these lenders. Normal securitization, like NHA MBS, require lenders to assemble $2+ million pools of mortgages that are very similar in attributes (similar term, similar interest adjustment dates, similar coupons, etc.). ABCP wasn’t as restrictive. It helped key broker-channel lenders sell off different and odd types of prime mortgages more easily (read, more cost effectively).

There are still a few workarounds for getting insured mortgages into ABCP conduits (e.g., by turning them into NHA MBS pools, paying a guarantee fee and then selling them into ABCP conduits), but that’s more expensive. Once again, these extra costs will be passed straight through to consumers.

The New Purpose Test

Here’s where things get dicey. The DoF has a new “purpose test” starting this July for mortgages that are portfolio (a.k.a., “bulk”) insured. Lenders that bulk insure mortgages will have six months to securitize them. If they don’t, the insurance on those mortgages will be cancelled. (There are a few exceptions, including but not limited to, a 5% buffer and an allowance for delinquent mortgages.)

The goal of this purpose test is to ensure lenders use bulk insurance for securitization purposes and not capital relief (a strategy where big banks insured mortgages and used the “zero-risk” status of those insured mortgages to avoid setting aside capital against them).

This new “purpose test” sounds fairly innocuous, until you look at it from a small lender’s eyes. Small lenders don’t have balance sheets like the major banks. If they fund a mortgage that isn’t eligible for securitization, they have a problem.

Small lenders, for instance, can’t securitize 1- or 2-year terms very effectively. Securitization pools must be at least $2 million, be grouped by amortization, have similar interest rates and cannot be overweighted with big mortgages. As such, the little guys don’t have enough of them to pool and they don’t have a large array of buyers for these short-term mortgages.

The net effect is that smaller lenders (and new entrants) probably won’t be able to price 1- or 2-year terms as competitively. They’ll likely have to sell to big balance sheet lenders (a.k.a., “aggregators”), potentially at margin-squeezing prices. Even if they could pool them, the result would be a larger number of small pools, which are more expensive to sell to investors.

Practically speaking, this could be a real problem for:

  • renewing borrowers who want a shorter term from a non-bank lender
  • borrowers who want to refinance (e.g., Someone with two years left on their mortgage who wants to add $50,000 to it can typically blend and increase with no penalty. Going forward, smaller non-bank lenders may limit this feature on terms less than three years)
  • variable-rate borrowers who want to convert into a shorter-term fixed mortgage (more lenders may start restricting variable-rate conversions to 5-year terms only)

The Takeaway

This latest onslaught of mortgage regs could soon reduce liquidity for non-bank lenders with less diverse funding sources than the banks. Remember that when you hear the DoF and CMHC lauding how their policies foster competition in the mortgage market.

These changes are especially painful to smaller lenders who can’t pool enough mortgages cost-effectively. The result could be more one-dimensional product offerings (e.g., 3-year and 5-year terms only, and fewer mid-term refinance privileges) for these very important bank challengers.

This, in turn, raises costs for customers both directly and indirectly. For mortgages funding after June, there will be a literal step-up in rates. In addition, there’s the indirect impact from less rate competition from smaller lenders. Remember, rates are set at the margin. Consumers have been increasingly exposed to competitive rates from bank challengers, and that in turn influences big bank pricing.

All of this is in the name of reducing government exposure to mortgages, mortgages that have proven time and again to be one of the lowest-risk asset classes in Canada.

Did the federal policy-makers envision all these side effects when they instituted these rules? We have to assume they did, and chose to do it anyhow.

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Last week, CMHC’s Housing Market Assessment (HMA) cited “strong evidence” of increased housing risk in Toronto, Calgary, Saskatoon and Regina.

Here’s a visual summary of the insurer’s findings:

Source: CMHC

Source: CMHC

 

Many don’t realize it, but mortgage lenders take these assessments seriously, and for multiple reasons. For example:

  1. CMHC factors in HMA risk when deciding whether to approve an insured mortgage. While CMHC says its loan eligibility criteria is the same in all markets throughout Canada, it adds: “HMA is considered in emili as a factor which influences the risk of an application…CMHC’s decision to insure a loan is based on an overall risk assessment of the mortgage application. Local market conditions, alongside borrower, property, and loan characteristics influence this overall risk assessment. Applications considered high risk based on a combination of these characteristics may be subject to additional mitigations.” In turn, when CMHC underwrites an application in a higher-risk market, it’s more likely to ask for a physical appraisal, or ask the borrower to put down more money, reduce the loan amount, add a co-borrower, or so on.Housing market FB
  1. Lenders all get their money from someplace, and to the extent they use investor funds, those investors sometimes get edgier about lending in higher-risk markets. This, in turn, leads to incremental guideline tightening and less flow of credit to those areas.
  1. Federal policy-makers are eternally vigilant when it comes to risk warnings, and they rely heavily on CMHC’s research. That, again, can lead to policy tightening, including measures the public doesn’t see. OSFI, for example, can, and has, issued guidance to banks to encourage more conservative lending in high-risk markets.

 

All this said, if you’re a strong borrower in a higher-risk city, don’t get too worried. The consumers who are most affected are those who are riskier to begin with. That means people whose credit scores are below average, whose debt ratios are above average and who are only putting down the bare minimum. For those folks, good luck with getting those 5% down high-TDS condo purchases financed in Toronto.


TDS refers to “total debt service” ratio.

 

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Announcement FBB.C.’s mortgage broker regulator, FICOM, updated the industry Friday on the contentious new compensation disclosure guideline. (More on that contention)

FICOM said it processed 70+ comments about the new policy. Here’s what it concluded:

Simpler Disclosures are Better

The Mortgage Brokers Act regulations prescribe a one-page “Form 10” that brokers should use to identify conflicts of interest that might sway the broker’s advice. This form will replace the multi-page version that’s widely used today.

According to Carolyn Rogers, the Registrar of Mortgage Brokers at FICOM, “Most consumers will find the prescribed one-page Form 10 simpler to absorb than the multiple pages in the [current] enhanced Form 10.” 

Consumer Guidance

Probably the best news from FICOM’s announcement was this:

“We are also contemplating the development of information for consumers, to ensure consumers understand why they’re receiving conflict of interest disclosure and how to use the information they receive.”

Misinterpretation of this new disclosure has been one of the industry’s biggest concerns. Research has shown that mortgage shoppers can choose a less optimal mortgage provider if they deem the broker’s compensation somehow abnormal, even when it’s not.

It’s certainly helpful that FICOM will (potentially) issue guidance to homeowners on how to interpret the disclosure. Ideally it will explain the normal range of compensation in our business so consumers can better judge what’s “fair.” Albeit, that context should speak to the complexity of certain applications and the different service levels in our business. Difficult-to-place clients (e.g., those with weak credit, unprovable income, etc.) should sometimes expect their broker to earn more due to the specialized and time-intensive nature of those applications.

Industry Guidance

“The Registrar will publish guidelines, developed with industry input, that describe how we expect brokerages to review and disclose conflicts to consumers,” said FICOM in its statement.

Of particular interest is how brokers will be expected to estimate the dollar value of lender bonuses or status perks, which often depend on volume or unit sales that cannot always be foreseen.

“We anticipate the release of improvements to conflict of interest disclosure by no later than September 1, 2016,” FICOM says. The actual rule won’t take effect until later, however (no later than January 1, 2017).

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The cost of funding a mortgage is going up again, thanks to new federal regulations due this fall.

Canada’s banking regulator (OSFI) announced Friday that it will “change” (read increase) regulatory capital requirements on mortgages. The rule change takes effect November 1, 2016, after a public comment period.

“These updates will ensure that capital requirements remain prudent in periods where house prices are high relative to household income and/or house prices are increasing rapidly in nominal terms,” OSFI said in its announcement.

The rules will force seven large banks to put aside more capital for mortgages in potentially overvalued cities. That will add a bigger buffer if the market sells off and these banks start incurring losses. The lucky seven in question include RBC, TD, Scotiabank, BMO, CIBC, HSBC and National Bank. Together, they account for the majority of Canadian lending, so this rule will have a widespread impact.

Upon implementation, the proposed new capital requirements will be calculated using an OSFI-approved formula for price correction risk, which in part is based on Teranet – National Bank’s House Price Index.

OSFI adds: “…Potential losses may become more severe during extended periods of rapid price appreciation and/or periods where house prices are unusually high relative to household incomes – since the value of the collateral underpinning these loans is likely to be less certain in those circumstances.”

It’s too early to tell how much this policy will cost banks. But I’d be surprised if it raised mortgage rates more than 5-15 basis points nationwide. 

Interestingly, since banks usually price the same across the country, a person in a lower-risk housing market could effectively be subsidizing the rates for someone in a higher-risk market.

If you’d like to comment on this proposal, send your thoughts to OSFI here, by June 10.

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Last December, the credit union trade group released a paper on credit unions’ role in the mortgage industry. While somewhat belated, it contains statistics worth mentioning and statements worth debating, not the least of which is their take on mortgage brokers.

Here, in no particular order, are some of its key points. The source is the Credit Union Central of Canada (now called “Canadian Credit Union Association” or CCUA):

CUs in the Mortgage Market

  • 58%: The percentage of credit union loans that are residential mortgages
    • In 1961 it was just 12.7%.
    • “…residential mortgage lending is now at the centre of credit union business,” notes Rob Martin, author of the report.
  • 8.9%: The average annual increase in mortgage balances at credit unions, from 2009 to 2014
    • Compared to 5.5% at banks over the same period.
  • Mortgage market share (outside of Quebec):
    • Highest penetration: 35.9% in Manitoba
    • Lowest penetration: 4.5% in Newfoundland
    • Ontario: 5%
  • 380: The number of communities in Canada in which a credit union is the only financial institution physically present.
    • It’s truly hard to overstate the importance of credit unions to small and rural communities.

Default Statistics

  • 0.29%: Mortgage arrears rate among federally regulated institutions (e.g., banks)
  • 0.13%: Mortgage arrears rate among provincially regulated institutions (e.g., credit unions)

“Credit union mortgages have very low arrears when compared to other institutions…below that of all other institutions with mortgages in [mortgage-backed securities] pools,” according to the report.

Sound Underwriting

Credit Unions FB

In the past, competitors have knocked certain credit unions for their higher loan-to-values, lower qualifying rates, stated income programs, cash-back mortgages and/or longer amortizations. But these criticisms don’t reflect the underwriting prowess of credit unions.

In actuality, the report notes that when compared to other lenders’ CMHC-insured mortgage performance, credit unions:

  • Make fewer default insurance claims 
  • Have lower early delinquency rates (EDRs)
  • Have a higher Misrepresentation Susceptibility Index (MSI) score, meaning they’re better able to detect mortgage fraud and other misrepresentation by borrowers, and
  • Arguably have better knowledge of their local markets, since they lend in their own communities.

Potential Effects of an Insurance Deductible

CMHC has publicly disclosed that it’s evaluating ways for lenders to share more default risk on insured mortgages. Speculation is that CMHC may impose a deductible on lenders when they make an insurance claim.

To that, CCUA says, “If a deductible is significant, the likely impact will be increases in mortgage credit costs for consumers and a reduction in mortgage credit availability for…home buyers. The impact of these changes will be most significant for lower income Canadians, Canadians living in rural/remote regions, or in areas with a fragile economic base.”

It adds: “These outcomes would…be at odds with CMHC’s role to serve underserved areas and fill gaps in the market.”

Effects of Low-Ratio Insurance Tightening

CMHC has cut back insurance for mortgages with a loan-to-value of 80% or less. It has also increased the costs to lenders for insuring and securitizing those low-ratio mortgages.

CCUA states: “…the elimination of low-ratio transactional mortgage insurance may have [a] similar negative impact on…homeowners in small urban centers and rural areas.”

Low-ratio insurance is vital to certain credit unions that operate in illiquid local housing markets. That’s because insurance mitigates property risk—important with rural properties that have less certain valuations than active urban properties. Low-ratio insurance is also key for securitizing mortgages on smaller market properties.

Credit Unions and Mortgage Brokers

Here’s where the paper gets a bit questionable.

CCUA commented on the rising use of mortgage brokers, which it says increased their share of mortgage originations from 22% in 2005 to 31% recently.

CCUA positions credit unions’ “limited reliance on mortgage brokers” as an advantage, stating:

“This development points to an increased commoditization of mortgage products and a general decline in consumer loyalty to a single financial institution when seeking a mortgage…Consumers are increasingly willing to look beyond their primary financial institution for a mortgage and they are making a choice of institution largely on price.”

That begs the question, what is the implication? Do they mean that if you’re a consumer who doesn’t prioritize loyalty and wants an outstanding rate, CUs aren’t for you?

The report says the big six chartered banks source 27% of total mortgage customers through mortgage brokers, whereas CUs obtain 18% of members through the mortgage broker channel.

“The lower reliance of credit unions on mortgage brokers should not be surprising given the stronger customer satisfaction and loyalty displayed by credit union customer/members,” Martin notes, citing “FIRM survey” data to back his argument.

That’s one heck of a claim, and a somewhat specious one at that.

Perhaps if more CUs acknowledged consumers’ growing broker preference, and perhaps if more CUs chose broker distribution, the credit union industry wouldn’t be stuck at just 8% market share, a number that hasn’t grown materially for years.

Credit unions offer exceptional service and support their communities admirably, but they don’t get enough exposure. That exposure is exactly what brokers deliver. This fact is evidenced by:

  • Established lenders like Scotiabank—the top lender in the broker channel, and one that relies more on brokers to bring in mortgages than its own retail channel
  • New lenders like Manulife—which strongly endorsed brokers with its recent entrance into the market
  • Credit unions themselves—witness the robust mortgage growth of broker-channel CUs like Meridian, DUCA Financial, Coast Capital Savings and many others.

CU executives who buy into the proprietary distribution argument better have a foolproof online marketing plan or an inspired local marketing strategy. Otherwise, they’re missing out on a tremendous funnel of new business through the broker channel. Brokers deliver highly qualified borrowers for a one-time fee. CUs then keep all the renewal and cross-sale revenue for their members—not too shabby a deal.

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Back in December when the finance department hiked minimum down payments, it said the change would “dampen somewhat the pace of housing activity over the next year.”

If “somewhat” means “barely noticeable,” then the regulation has achieved its goal, at least in Toronto and Vancouver.

Effective February 15, the minimum down payment rose — up to 2.5 percentage points — on homes between $500,000 and $1 million. Since then, there’s been no perceptible slowdown in Toronto and Vancouver home sales. Those two cities, which are among the fastest-appreciating markets in Canada, were the primary targets of the Department of Finance’s new policy.

 

Vancouver Avg home price

In the first full month following the rule change, the Canadian Real Estate Association (CREA) says that sales of single-family homes over $500,000 were the highest ever in March, in both Toronto and Vancouver.

“While it is still premature to reach a verdict on the efficacy of this measure to cool Canada’s two hottest markets, the early evidence suggests that it had little effect to date,” RBC economist Robert Hague said in a research note. 

A breakdown of home sales by property value, courtesy of the Toronto Real Estate Board and the Real Estate Board of Greater Vancouver, further illustrates the runaway sales of higher-priced homes.

 

March data reveals that homes valued between $500,000 and $1 million rose 28% in Toronto and 27% in Vancouver compared to last year. There’s no telling what sales would have been without higher down payments, but take a $750,000 home, for example. An additional 1.67% down payment isn’t exactly an insurmountable obstacle for most buying at that price point.

First-time buyers will take the brunt of these changes. “The affordability of homes in these mar­kets has taken a further hit…,” points out National Bank Financial in a report this week. Following the rule implementation, “…The time required to accumulate a minimum down payment for the representative home increased in Q1 by 11 months in Toronto and by 34 months in Vancouver.” 

Moreover, while regulators have not materially slowed higher-risk housing markets, larger down payments have nonetheless had two positive outcomes. For one, new buyers in the $500,000 to $1 million range now have more to lose if they don’t pay their mortgage. In addition, as Hague notes “…We believe that the measure has enhanced the degree of prudence in the mortgage adjudication process.” And there’s nothing wrong with that.


Sidebar: Sales of homes valued at more than $1 million also exploded in March, up more than 60% in Toronto and Vancouver.


By Steve Huebl & Rob McLister