Craving Canadian Mortgage Investments

Canadian-Mortgage-Investments Foreign and domestic investors alike have been lining up to buy Canada Mortgage Bonds (CMBs).  In the last 12 months, the volume of mortgages funded by CMBs has risen 20%, according to CIBC’s Doug Bartlett.

It’s also noteworthy that investors are no longer demanding abnormally wide yield premiums over 100% safe Government of Canada bonds.

At the last Canada Housing Trust variable-rate auction, for example, demand was twice as large as expected.  $2.4 billion worth of mortgage-backed debt was sold at a meagre 0.18% surcharge over low-risk bankers’ acceptances (BAs).

Even the private sector is having success selling mortgage investments.  Last week, Equitable Group issued $45 million of non-voting stock for $25 a share. That’s rather impressive for a small non-prime mortgage lender in a recovering mortgage market.

  1. If these CMHC written CMB’s are backed by the Gov’t of Canada, then why are they less safe than Gov’t of Canada bonds?
    While we’re on the topic, some things to consider…
    Page 32 of the following report shows that annual CMHC CMB’s have increased from $40b in 2006, to est $160b in 2009.
    http://www.cmhc-schl.gc.ca/en/corp/about/anrecopl/upload/2008-Annual-Report-Management-Discussion-and-Analysis.pdf
    Page 36 of the same report shows that 30% of all Canadian mortgages are now securitized.
    Or consider this report…
    http://www.cmhc-schl.gc.ca/odpub/esub/63830/63830_2009_M06.pdf
    Page 6 of which shows that total Canadian mortgage credit has increased from $776b avg in 2007 to to $917b avg in Q1 2009. That’s a $141b (18%) increase in 1.5 yrs (from midpoint ’07 to midpoint Q1 2009). Furthermore, the same table shows that :NHA MBS’s” (ie the previously discussed CMHC MBS’s by a different name) represent #127b of that $141b increase.
    In other words, Canadian consumer mortgage debt has increased $140b in the past 1.5 yrs, and 90% of that money has been raised from the markets via 100% Gov’t backed mortgage bonds.
    So to clarify what is happening here…
    1. The gov’t has raised $126b of cash by selling gov’t backed CMB’s.
    2. This money is pumped into the Canadian housing market.
    3. This $126b represents a 16% increase in the mortgage debt.
    4. Mortgage debt represents 30% of housing valuations.
    (as from page 2 of the following
    http://www.caamp.org/meloncms/media/papers_Mortgage-Market-Update.pdf
    5. Therefore in the absence of this CMB fundraising by the gov’t, we would have 5% less money in the housing market (16% x 30%). However, I suggest that this 5% does not translate to a 5% price support over the past 18 months, but rather has a larger effect because it applies primarily to the relatively small proportion of houses on the market during that time.
    Another note about this report
    http://www.caamp.org/meloncms/media/papers_Mortgage-Market-Update.pdf .
    On page two, the graph shows Canadians with housing equity of 70% vs the US at 45% in 2008, and proclaims this demontrates a healthier market in Canada. Now consider that US national housing prices are down 25% from peak by the end of 2008. Now consider what happens to Canadian housing equity if our national prices dropped by 25%.
    Any rebuttals to my concerns above are certainly welcomed. :-)
    ps. I’m not an insider, nor do I work in the real estate or mortgage markets. I’m just an executive at an insurance company who gets bored at work and likes to surf the web ;-)

  2. Dave your right
    In a normal functioning market. total Canadian debt and assets would balance out. Interest rates would reach an equilibrium such that total lenders and borrowers match.
    I.e. if there are $100 billion of mortgages then there are $100 billion of term deposits.
    However because the Canadian government supports the housing market it creates artificially low loan rates pushing the market out of equilibrium. Meaning there are more borrowers than savers in Canada. The Gap has to be filled with foreign debt hence the CMB

  3. Jimmy,
    The point I’m rebutting is that the dramatic increase in gov’t backed CMB’s is not good news, but rather is very bad news. The only reason investors are buying them is because they are 100% gov’t backed and provide a higher rate of return than other gov’t backed bonds.
    For us to celebrate them is no wiser than our neighbours to the south celebrating their own securitized mortgage boom from the earlier part of this decade. (admittedly these were mostly not gov’t backed, but the US gov’t ended up bailing out most of them as we have seen)
    Further, the point is that the present stability in Canadian housing prices is presently maintained solely via the cashflow generated by these dramatic recent increases in gov’t backed securitized mortgages.
    Eventually the increases have to stop. For the consequences of this, once again just look to the south.

  4. Dave…For you to compare AAA insured Canadian mortgage-backed securities to American MBS shows clearly that you have absolutely no clue how the Canadian system really works.

  5. Kevin,
    As I said, I welcome corrections. Could you explain?
    thx in advance
    ps. the American MBS were mostly triple A as well.

  6. Good Point Dave … Can someone (like Kevin) please explain the difference between American AAA MBS vs Canadian AAA MBS. Please enlighten us.

  7. There is no doubt that mortgages guaranteed by the government as proportion of total mortgages outstanding have increased sharply over the past 2 years.
    Just take note of the different flavours of government backed MBS.
    CMHC guaranteed mortgages include general NHA MBS, Canada Mortgage Bonds (CMB) issued by the CMT, and mortgages purchased under the IMPP.
    NHA MBS are securities issued by CMHC approved lenders (ie. banks, CUs, etc). Those mortgages must meet guidelines set by CMHC (more or less).
    Canada Mortgage Bonds (CMBs) are issued by CHT (Canada Housing Trust – a special purpose vehicle). CHT buys the mortgages from financial institutions. CMBs are viewed as slightly less risky than general NHA MBS and thus generally offer interest rates that are slightly lower to investors.
    Both CMBs and general NHA MBS have the same government guaranteed payment of principal and interest. Further, media reports have said that mortgages backed by private insurer Genworth are not viewed as equal to CMHC backed mortgages. CMHC benefits from a 100% guarantee while Genworth only has a 90% guarantee. In good times no one seemed to care, but these days investors are very risk sensitive.
    Finally since October 2008, the government is purchasing insured mortgages directly from financial institutions through the IMPP (Insured Mortgage Purchase Program). This program has a ceiling of $125 billion.
    Often in the media the term NHA MBS is used to describe all government backed mortgages. However, just to be clear CMBs do not represent all NHA MBS.
    FYI. Not an insider.
    Jim

  8. Jim, great comments.
    One point is on the different yields between CMB and MBS. MBS trade at a discount not because of issuer risk, but because of the monthly cash flow in the form of interest and return of capital an MBS gives vs a CMB.
    It is simply a discount due to the re-investment risk of an MBS. A CMB is much cleaner, and similar to a plain-vanilla Maple.

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