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The Evolving Credit Market

Mortgage-Predictions Mortgage professionals are always interested in what the future holds for our business.  On Monday, CAAMP hosted a lender panel that provided some interesting forecasts.  It also explained where Canada’s mortgage industry is at today.

Four lender executives sat on the panel…

  • Grant MacKenzie – CEO, Macquarie Financial
  • Nick Kyprianou – President, Home Trust
  • Ron Swift – President, MCAP Service Corporation
  • John Webster – President & CEO, Maple Trust (Now part of Scotiabank)

Here’s a sampling of what each had to say…

On when the credit crisis started in Canada:

  • The first major signs appeared in August 2007 according to Grant Mackenzie and Ron Swift.  That’s when Canada’s commercial paper market went into panic mode.
  • Swift said he knew there’d be trouble ahead when investors then started halting purchases of subprime mortgages.
  • Things really took a turn for the worse this past September according to Mackenzie.
  • Swift agreed, saying the 4th quarter of 2008 was “much more devastating” to lenders in terms of risk.

On what lenders are dealing with now:

  • “Risk is still being re-priced,” according to John Webster. “Liquidity is the scarce resource. Everyone is paying up to get money.”
  • Mackenzie said Macquarie is “managing [lending] volumes with our internal warehouses and Canada Mortgage Bonds.”
  • Swift stressed that lenders, like MCAP, are increasingly having to prove to investors that underwriting is becoming more prudent (in order to obtain more lending capital).
  • Lenders who don’t have deposits have had a harder time says Swift.  That’s because lenders have a limit on the amount of mortgages they can sell using the Canada Mortgage Bond (CMB) program.  (The CMB program is the lifeblood source of capital for most smaller lenders.)
  • You might have a “$450 million cap per quarter,” he said.  “Therefore $1.8 billion a year is your maximum growth.”  (That is not a lot to most lenders–and is therefore a key problem affecting our industry at the moment.)
  • CMHC’s reverse auction program has alleviated the CMB limitations somewhat (because it doesn’t have dollar restrictions like the CMB program).  However, it is not as accessible to smaller lenders, and bigger lenders also run into a wall because they cannot exceed 25% of each auction’s available liquidity.

On Canada’s housing market:

  • Nick Kyprianou said lenders are currently very sensitive to the specific risks in each province.
  • “I’m seeing something much more severe than a 10% price correction–especially out west,” said Kyprianou.  In markets like Alberta, when labour and materials costs return to normal, market prices must fall he said.  Oil’s collapse has not helped matters either.

Canadian-Mortgage-Bonds On the Canada Mortgage Bond program:

  • “Thank God for the Canada mortgage bond,” Webster said.  He called it a “stable form of liquidity that’s made it possible for everyone to lend.”
  • Kyprianou stressed that it’s currently very difficult for lenders to plan their financing using the CMB program.  One of the reasons, he said, was that “we didn’t find out until last week what the allotment was.”  (Home Trust’s CMB allotment was $440 million this quarter by the way)
  • Ron agreed. He said there is a lot of uncertainty as to future CMB issuances.  That makes it very hard for lenders to plan their ability to fund new mortgages. In other words, lenders don’t know what liquidity will be like when they go to sell their mortgages to the market.
  • If it turns out that CMB’s aren’t sufficient to fund a lender’s mortgage commitments, a lender then needs to sell its mortgages via other mortgage backed securities, which can be “much more expensive,” said Kyprianou, “especially if you’re costing based on the CMB.”
  • Swift said lenders have been “cut back” in the CMB program. That’s forced MCAP to decrease its lending considerably.
  • The price of money has been steep.  Lenders paid 0.65% above the CMB rate in September in order to get mortgages off their books.  In October it rose to 1.00% above CMB’s.  The government’s reverse auction was priced even higher!

On Variable-rate Mortgages:

  • Webster said variable-rate mortgages are the most difficult to fund in this market.  He called the variable market “unstable and unpredictable.”
  • Home Trust doesn’t have a variable mortgage and Kyprianou says it’s because short-term capital planning is incredibly hard to do right now.  He said very candidly, “We don’t have a variable because were not smart enough to know where things are going.”

On lender survival:

  • Kyprianou appeared quite certain that certain lenders might not make it through the next 12 months.  He said there are “a few more to go” (i.e.  fail).

On Broker Compensation:

  • “The biggest controversy has to do with aggregation…Brokers used aggregation to leverage up their commissions…that time has passed,” Webster said.
  • Kyprianou stressed that it costs money to underwrite mortgages.  He said there “needs to be a consequence attached” when brokers have cancellations and poor funding ratios.
  • In 2009 lenders will “focus on relationships and there will be fewer of them,” according to MacKenzie.
  • Swift said, “I measure what I get from the firm, but also from the agent.”  MCAP also looks at how an agent’s mortgages have performed after funding as well as renewal statistics by individual broker.  MCAP wants to better match a broker’s compensation with these statistics.
  • “Simple volume doesn’t work as a model,” Swift said.  He told the audience that brokers will get paid “more” but they will also need to work “more for the lender.”

(For the record:  From a borrower advocate standpoint, we are uneasy with anything that encourages brokers to deal with fewer lenders.  Hopefully “working for the lender” doesn’t mean brokers will make the wrong choices.  In general, the fewer lenders a broker uses, the greater the odds that customers’ interests are compromised.)

  • To properly determine compensation, Webster said, “We need to know what the [mortgage] assets will net us.”
  • Home Trust, like all lenders, calculates almost every possible expense when determining their net yield on a mortgage.  They even track which brokers send them “high maintenance” clients, because those mortgages cost Home Trust more to service.
  • Over the next year brokers will need to understand what lenders need, Swift said.  “There has to be a change…[Brokerage volume] aggregation is not a sustainable [compensation model].”

bank-bankruptcy-mortgage On the subprime lenders who are no longer with us:

  • Canada’s subprime lenders are a very small part of our market Webster said. The subprime fallout in Canada has therefore not been catastrophic.
  • Kyprianou has seen the portfolios of lenders who have failed in the last 14 months.  He said many of their loans were at 98% loan-to-value.  Moreover, “arrears were near 5% on some of the companies that have gone under.”
  • Kyprianou said the “self-insured business that I have seen doesn’t look very good.” (Self-insured lenders are almost non-existent in Canada these days.)

On the next 12 months:

  • The panel predicted that broker market share will continue to grow, but Swift said there are “more tough times ahead” for lenders.
  • “It will get better over the next several months,” Webster thinks.
  • Lenders will be bending over backwards to get more volume said Webster. It is, and will continue to be, a very competitive market.
  • Kyprianou seems to have a preference for purchases over refinances in this market.  He said his underwriting department is very cognizant of how many times someone refinances.  Borrowers that have had multiple refinances are now frequently not getting approved.
  • The capital markets are the key to lenders’ success in 2009.  “I hope the government responds with consistent liquidity,” said Swift.  He said there is a clear need for more reverse auctions and CMB issuances.

On miscellaneous matters of interest:

  • Swift said that, despite the media attention, “40 year and 100% financing products are not causing us a problem in Canada.”
  • Non-bank lenders are having a tougher time than banks suggested Kyprianou.  In a somewhat humourous and contentious moment, Kyprianou said, “We don’t have a bank to write a cheque if things get bad.” Webster (now with Scotiabank) didn’t seem to find that too amusing.
  • Swift implied that Canadian Brokers’ jobs are not necessarily safe.  He said broker market share in the U.S. was 70% two years ago, but has since plunged to 30% today.

(Folks need to remember that Canadian brokers operate very differently than their U.S. counterparts.  Webster put it simply when he said there have been “no truth in lending” issues in Canada like there have been in the US.)

  • Panel moderator, Michael Campbell, reminded bank-bashers to be careful what they wish for.  He said that if Canadians have a problem with the profits Canadian banks are making, they should take a look at the alternative:  the disaster affecting U.S. big banks.