“Risk-Off” in the Canadian Mortgage Market

risk-of-mortgage-insuranceThere’s a growing air of uncertainty in the mortgage industry, one we haven’t sensed since the tail end of the credit crunch.

Regulators, media and politicians are waving the caution flag on housing and mortgages, and the foundation of our market (CMHC) is suggesting they’re running out of insurance room.

This has much of the industry in a risk minimization (“risk-off”) mode. In turn, mortgages that are not insurable, income-qualified and owner-occupied are now attracting more scrutiny.

Here’s what we’re hearing…

On CMHC’s $600 billion insurance cap…

  • CMHCThe consensus among industry executives we spoke with is that CMHC will not receive near-term approval to write more than $600 billion worth of mortgage default insurance. Political and risk concerns are the most cited reasons for this.
  • That may change if CMHC approaches parliament with urgency to lift its cap. (We don’t have enough information to judge this probability, so we won’t.)
  • “The government doesn’t want lenders insuring low loan-to-values,” one capital markets expert told us, on condition of anonymity. Insuring low LTV mortgages suggests banks are abnormally concerned about risk and eager to find a way around OSFI’s capital guidelines (buying mortgage insurance lowers banks’ capital costs in many cases).
  • Lenders are reportedly disproportionately relying on low-ratio insurance to cover themselves on mortgages in Toronto and Vancouver where price risk means 80% LTV is less security than in most cities.
  • “There is a false comfort in loan-to-values.” It’s often better to have more room to service debt, than more equity, said the above source. “If I’m choosing between an 80% LTV with a 42% TDS and a 95% LTV with a 30% TDS, I’ll take the latter.”
  • We’ll find out how close CMHC is to its present $600 billion cap when it issues its 4th quarter financials (due by month’s end).

On covered bonds…

  • Bond-dealersPressure to increase the $600 billion ceiling may wane if the government decides it will no longer guarantee covered bonds. (We could hear more about that in the next 30-60 days when new covered bond legislation is rumoured to be due).
  • Covered bonds used up roughly $24 billion of insurance capacity in 2011.
  • The government’s position is that covered bonds don’t need to rely on insurance, and that’s true in some cases.
  • The Covered Bond Report cites evidence that RBC’s covered bonds (which are backed by uninsured conventional mortgages) demand yields as low as five basis points above insured covered bonds. (That’s a tight spread. Albeit, other issuers would likely pay more than RBC, given its strong credit rating.)
  • Our key source above told us: “The Feds are going to have to increase the covered bonds limit if they’re serious about not harming liquidity.”

On lenders’ backup plans…

  • contingency-plansWord is, a slew of lenders have been on the phone with Genworth and Canada Guaranty. They’re looking for a replacement to the bulk insurance they can no longer buy in size from CMHC.
  • We spoke with other knowledgeable sources who speculate that private insurers may only be able to fill demand for a year or so before hitting their own insurance limits.
  • Another question is, what cost premium will investors demand from lenders in order to buy mortgages backed by private insurers (who have a 90% government guarantee versus CMHC 100% guarantee). At the consumer level, a 10 basis point interest rate disadvantage is a turnoff in today’s competitive mortgage arena.
  • Non-bank lenders have been calling “every available liquidity source” one lender executive told us yesterday.
  • Another lender said: “Investors’ appetite for private insurance will dictate how much conventional business monolines do…Banks can withstand this because they will put it on their balance sheet….with no conventional rate premium.”

On CMHC portfolio insurance limits…

  • The ramifications of CMHC nearing its $600 billion insurance cap are potentially great. The most noticeable outcome so far has been CMHC’s first-ever bulk insurance rationing system. Depending on how CMHC allocates bulk insurance to lenders, it could:
    1. adversely impact smaller lenders who rely on portfolio insurance for liquidity OR provide an advantage to certain smaller/newer lenders (depending on whether their cap on buying bulk insurance is based on an industry average [which could be relatively large for a small lender])
    2. adversely impact major banks that use portfolio insurance for capital relief.
    3. adversely impact consumers by way of fewer product options and higher rates on low-ratio mortgages
  • Ron-SwiftRon Swift, CEO of Pacific Mortgage Group Inc., told us yesterday: “The result of these restrictions ultimately means there will be an impact on liquidity in the market place. I think this will first impact products that have the higher insurance costs, such as stated income & self-employed. They will either be stopped or the rates charged to these clients will have to be significantly increased. Either way, tightening liquidity, reducing mortgage options or increasing the costs will take some buyers out of the market, which will affect all of us.”
  • Thus far, we’ve seen a handful of non-bank lenders announce higher conventional (<=80% LTV) mortgage rates. More are expected to follow.

On stated income mortgages…

  • OSFI, Canada’s bank regulator, has been concerned about stated income mortgages for months.
  • firstlineFirstLine, a major lender and one of CIBC’s mortgage divisions, dropped a bombshell on brokers Tuesday. It announced that it’s suspending stated income approvals effective immediately. (Refis and switches among CIBC’s own brands are not impacted.)
  • We’ve already heard of other lenders either terminating their stated income programs or upcharging the rates.
  • As a side note: CIBC says its “changes affect FirstLine only,” which will really tick off brokers. It seems that CIBC’s decisions to: a) apply this policy only to brokers, b) severely undercut brokers on renewal, and c) apply rate favouritism to its retail channel, are destroying FirstLine’s long-standing goodwill among brokers. We hate saying that because we have all the respect in the world for the BDMs, underwriters and management we have had the privilege of knowing at FirstLine. This decision obviously comes from above their heads.

On the lead time CMHC gave to lenders…

  • last-minute-announcementCMHC seems to have been caught by surprise by the demand spike for bulk insurance. Lenders were reportedly given barely a month’s notice that they would be subject to rationing of this insurance.
  • Some had no idea how much less portfolio insurance they’d be permitted to buy until this week. It turned out to be drastically less, and it could materially impact their business models, especially for smaller lenders who rely on this insurance for securitization.
  • One lender exec said that CMHC should have provided at least 90 days notice so lenders could plan contingencies. That individual summarized the new default insurance allocation process with two words:  “Bad execution.”

On who wins in all this…

  • winnersB Lenders
  • The Big 6 Banks
    • On one hand, they lose due to higher capital costs—as CMHC tightens the tap on bulk insurance.
    • They could gain however in terms of market share on conventional mortgages. That depends, of course, on how widely available CMHC portfolio insurance is going forward.
  • Mortgage insurers Genworth (TSX: MIC) and Canada Guaranty
    • Demand for private insurance may increase, for at least the remainder of 2012 anyway.

It bears noting that the situation is relatively fluid at the moment. Things may change and nothing is written in stone. Perhaps we’ll see CMHC make a statement soon that reassures the market. In any case, we’ll know more as the next week unfolds.

Rob McLister, CMT

  1. Rob,
    Congrats! Two blockbuster posts in a row. Great analysis and insight.
    If the actions pan out as mentioned above, I believe the Govt. and banks are trying to let the air out of the balloon slowly (soft landing). If CMHC limits are increased, I believe the bubble will continue to grow making it fall harder that required, causing big pain overall. Let’s hope the soft landing scenario occurs as planned, though the risk of over-reaction is omnipresent.
    “There is a false comfort in loan-to-values.” It’s often better to have more room to service debt, than more equity, said the above source.
    This substantiates my comments yesterday that the ‘45% equity’ cushion is false comfort metric. Only my anecdotal observation from talking to several colleagues and friends, the level of acutal cash equity is very low in the recent purchases, that it a scary scenario. Thankfully, someone in the industry & govt is also concerned.

  2. Very positive news as far as I’m concerned. The market is finally taking a serious look at the risks with CMHC, and how it is being abused by the lenders.
    More of this!

  3. This just in, Scotia is terminating their beautiful Start Right program. In Vancouver, that is a big hit to certain brokers.

  4. Another great article Rob and thanks for the economist link Watchdog.
    Being that I’m 28, in the high LTV segment in Calgary, in the middle of building a new home and trying to sell my current place this issue is still concerning to me.
    I do find comfort in the fact I’ve done my own detailed GDS and TDS budget since I really don’t trust some brokers out there that really come off as seeing us as just another commission.
    It really does scare me how some people can push those TDS limits. Couldn’t they just push up the qualifying rates to pad those numbers, reduce risk and purchasing power and slow the bubble down to a halt to help stabilize the housing market prices until the personal incomes catch up? Furthermore, it seems to me like qualifying rates should be even more tightly linked to personal credit score and the amount of bad debt one really has (or may potentially have).
    I’m sure it’s not that simple but hey, I’m a software developer by trade. I just wish this site would have been around 5 years ago before I made a horrible decision on my first mortgage term.

  5. GDS and TDS are not good indicators in a volatile-inflationary economy. They can only be used when a currency is in equilibrium, where incomes and inflation rise in tandem. By this way, when a borrower calculates personal expenditures, such as gas at today’s prices, it is safe to assume their wages will rise to compensate purchasing power. Instead what we have today for example; a couple who purchased a home 3-4 years ago may have calculated their monthly gas costs at $600, which has risen by 30% since that time, increasing the cost to nearly $800 while their wages have stagnated or even been reduced by not receiving bonuses. This is one of many variables (food, travel, clothes, ect.) that is impossible to predict in an unstable economy, and the reason why many are having a hard time making payments.

  6. Completely disagree.
    There is a massive difference between 44% TDS and 34% TDS.
    Debt service ratios are one of the best indicators of potential default, especially in this market where home prices put LTVs into question.

  7. What inflation? 2-3%? Who cares? So what if costs go up 15% in five years. Big deal. That won’t keep 99% of insured borrowers from debt servicing. There is such a thing as income gains that you’re forgetting.

  8. Skewed nominal statistics is what distorts ‘market knowledge’ that investors use to value assets, e.g. income growing at 1.1% and inflation running at 2.9% (actually higher), is a wage loss of 1.8%. If this trend continues and the spread widens, the borrower will eventually default.
    But you’re right, who cares (if you’ve been in the lending/banking business). Just keep forcing them to pay their mortgage because home prices will always go up, until they don’t.

  9. Firstline is dead to me as a broker. They could just as soon close their doors now. I couldn’t care less. If CIBC wants to give preferential treatment to its sales force I am happy to take deals from them all day long.

  10. What I dont understand how every brokerage website states that they deal with 75 Lenders! isnt really only less then 20? First National,MCAP, Scotia, TD,FirstLine, Merix,Street, Radius, Icici,ING,Moncana,HomeTrust, Equitable, and couple more!
    The industry has lost BMO,HSBC,Resmor(2 more months), Concentra, Wells Fargo and few more to Come!,…..
    There will be always a role for broker but the industry’s market share will dcrease to 10-15%, the number of brokers will decrease by 25% andfew of the super brokers will go out of business!

  11. I agree, the net income should be taken into the criteria as well, not only the TDS stuff. The cost of living (food, transportation, etc.) has been going up much faster than the official inflation rate.

  12. Canadian Watchdog has some true points there.
    I agree with him, many other factors way affect the whole calculation

  13. thanks Rob, great article. I always want to be positive in my role as a BDM with my broker meetings, but it is more important that everyone understands the details of what is going on in the industry we work in, and are passionate about, even if the news is negative. We can’t stick our head in the sand like many did in 2007, knowing what is going on helps the whole industry adjust, adapt, and move forward…jumping the hurdles that come up. Keep the info coming!

  14. “You can’t fire me, I quit!”
    In the US, they were shocked, SHOCKED to discover, after the bust, that brokered loans had significantly higher default rates than in-house. Which isn’t to say that all brokers are bad, but “Would I lend money to this person?” is a fundamentally different question than “How can I get somebody else to lend money to this person?”

  15. Another great article Rob, super team or not this is many hours of research and thanks for it.
    I think there is a simple problem the government, the banks and the insurers are trying to deal with: a property value bubble. The parties involved have different agendas but they all have the same issue.
    For those of you who think there is no such bubble I would draw your attention to the OSFI pages that Bloomberg somehow got their hands on. The lenders have insufficient data to properly understand how many condos under construction in Vancouver and Toronto have been bought by people who are not citizens and who do not live in Canada.
    Although those folks may have given big deposits on their hole-in-the-ground purchases they can still walk away from the transactions with zero legal implications other than losing the deposits.
    Everyone who sells condos for a living tells me these buyers are so rich that they will close on the purchases even if they know they cannot flip them at closing but personally I am not so sure.
    Those of us who were in Toronto for the 1989 – 1990 real estate crash will clearly remember the problem started with the new condos and spread from there.
    Deleveraging real estate is a very painful experience (Hello USA) and thats what all these players are concerned with.
    Everyone hopes for a soft landing including me; but if your are a student of history you quickly realize soft landings at the end of a real estate cycle have actually never happened.

  16. Lets be realistic- there was a big party for alot of people in the mortgage industry for years- 40 year ams, 0 % down even on rentals! high TDS.. The party is over and the reality of the hang-over is now setting in. Batton down the hatches boys and girls.

  17. It depends the segment you’re serving. I have always considered the number of lenders some brokerages post to be somewhat ridiculous from a marketing advantage POV.
    The truth is even though I have access to over 30 lenders, in reality I use less than 10:
    2 or 3 on the prime/”A” side, 3 or 4 on the self-insured/small commercial, and 2 or 3 private lenders.
    Quality and service trumps quantity. The truth is it’s a pleasure to work with trust companies and credit unions as they really think outside the box to accommodate a deal.
    When I started in the business, HSBC, BMO, Well Fargo were already long gone so their presence never affected my business.

  18. I remember the crash of 1989-1990, and condo’s were the first symptom of the coming crash. They were not the cause of the crash however.
    If you recall, there were two separate events that contributed – first to the overbuild in markets like Toronto and second to the price correction that caused these overbuilt condos to deflate.
    The first event was the calling of the Assisted Home Ownership Plan loans introduced in the late 1970’s. If you recall that little misadventure, you’ll remember that the federal government – in an effort to stimulate the economy – offered first time home buyers up to 7% of the purchase price in a low interest, second mortgage loan to help them purchase their first home if they could come up with 10% down. The loans weren’t to be repaid for 7 years, so when the loans were due for repayment, wages and housing values had not increased enough to support the new payments so people bailed on the property. Ajax and Pickering were particularly hard hit by this initiative and the high gas prices at the time.
    The second trigger was the termination of the RHOSP in 1985 which fuelled a quick escalation of house prices through the mid-80’s, triggering a rapid uptick in condo construction, particularly in Toronto, which needed (and still needs) developer dollars to balance its books. I know because I had purchased property that escalated by over 100% within days of closing the deal in Sept/85. (I was offered $120K the day I moved in, when I had purchased the property for less that $55K just two months before).
    We’re seeing the same rapid build out of the condo market to feed city governments who need the development dollars to reduce the impact of high cost, low value add services to its citizens without making the citizenry pay for those services.
    So, will condo prices tank? I don’t know – I can only tell you that just across the street from me a developer is seeking a variance to build an additional 1484 units in the GTA and just up the street, they are hoping to build another 795 units. This doesn’t include 175 new townhouses and retail space. And this is at the tail end of a building cycle?
    Either the developers know something the analyst don’t, or they are in for a rough time to get those units sold.

  19. TORONTO, February 3, 2012 — Greater Toronto REALTORS® reported 4,567 sales through the TorontoMLS® system in January 2012.
    This number was 8.8 per cent higher than the 4,199 sales reported in January 2011.
    The average selling price for January 2012 transactions was $463,534 – up by almost nine per cent compared to January 2011.

  20. Hi Ralph,
    It’s quite different in Canada because underwriting and supervision is vastly tighter here than it was in the U.S. Default rates are therefore comparable in both channels.
    It’s different at every lender but broker-originated mortgages can have lower default rates than bank-rep mortgages. We were talking to a major bank about this very topic yesterday, and it’s why this particular bank is such a broker advocate.

  21. JohnH, I can’t say I have a crystal ball, all I know is there has never been a “soft landing” in any real estate cycle in the last 50 years in the western world. USA, Sweden, Spain, Canada, its a very long list.
    As for the developers, let’s face it, if they think they can pre-sell, they will build.

  22. Robert,
    Although it is stated that Canada’s lending regulations are tighter then the US, what we have can be considered (partially) an artificial sub-prime crises by mid-income-qualified individuals who took on mortgages within five years or so, whose incomes have stagnated, while living costs have increased (some having children), making financial livings conditions very difficult for them and possibly forcing them into bankruptcy.
    As you may know, recent bankruptcy stats (OSB stats) have declined, however this is only due to a court ruling that allowed exemptions and debtors to file proposals to their creditors, which we see trending upwards in this chart. http://i41.tinypic.com/65aha8.png This is not a good sign as the vast majority of claims are consumers over businesses.
    We have a structural income and jobs issue that can not be addressed by lowering rates or accessible loans. There is ‘hot money’ creating bad debt that will have to be purged out of the system.

  23. Hi CW,
    Re: “what we have can be considered (partially) an artificial sub-prime crises”
    Just trying to better understand your position. Is your basis for that statement primarily that the average mortgagor’s total debt service (TDS) is too high because incomes haven’t kept pace with inflation?

  24. The problem with low inventory is one for buyers not sellers. Prices will continue to rise in the GTA unless listing inventory picks up dramatically

  25. The mortgages you refer to have a high degree of equity. Only a small number of non-prime borrowers could be considered “vulnerable.” Most are self-employed, have good earnings potential, and/or have additional assets for security. They simply fail to meet normal lending guidelines, for whatever reason.
    Remember that you cannot make money as a B lender with high default rates. There is no incentive to take unnecessary risks. Alternative lenders underwrite very capably in this country and they charge appropriate interest rates for the risk they incur.

  26. Rob,
    Amazing content that you provide here as always.
    I agree that Firstline is dead in the water. These actions to play fair with their own team but to leave the Brokers in the dark truly shows the way this market is heading. True that there is no hard feelings towards the BDM’s, underwriters, etc. because without their personal support we wouldn’t have had great success with them for so long.
    Its time to show more support towards those B lenders though. I think lenders like Equitable and the new kid on the block Moncana will step up to the plate and fill that void for us.
    Stats show that an increasing amount of the population is becoming self employed so this part of the business isn’t dying as it is in fact growing.
    Support those who support us folks, the writing is on the wall. At the snap of a finger the Big 6 could turn off the tap and arm their “specialists” with all the tools and cash to come after us. Also, ask your Realtor referral partners who still send clients to the branch how long they think it will be before Banks start to list homes…..think about it. Shareholders are never happy with flat results. Its coming.
    Thanks again Rob, great quality.

  27. Rob I have been in the industry for 22+ years and your site is some of the best insight commentary on this industry that I have seen during that time-kudo’s to you and your staff.
    Canadian Watchdog,Outsider,TCM1 and Peter interesting conversation on qualification via GDS,TDS.For my take on that check out my three budget videos and my “Kraft Dinner Flambe Syndrome” videos on Facebook “Mortgage Straight Talk

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