Several smaller lenders are now running promotions on insured quick-close (IQC) mortgages, specifically those with 5-year fixed terms.

“Quick closes” are mortgages that must close within 30-45 days—sometimes within 60 days.

“Insured” means the borrower must pay a default insurance premium—which is routine when you put down less than 20%.

A greater number of IQC promotions have started popping up within the past week. Those specials generally entail either:

• lower rates (e.g., ~10 bps extra discounting), or
• slightly higher compensation for brokers (which brokers often pass on to the client in some form).

5-year IQCs are the most competitive part of the market right now. That’s because funding sources are most plentiful for these types of mortgages, especially if the insurer is CMHC. The short closing timeframe also reduces a lender’s interest rate hedging expenses.

Greater availability of capital and lower costs permit more aggressive competition. Moreover, some lenders actually need to push 5-year fixed terms because their limited funding options give them few other competitive products to offer.

This competition is all dandy for consumers of course, but there’s a side effect for lenders. It typically results in lower margins (i.e., tighter spreads) over time.

At the moment, however, margin impact is muted because the Big 5 banks are successfully managing to keep spreads fat (as they have for months…apart from January’s side-trip to 2.99%).

Unfortunately, the trend in aggressive IQC pricing is not carrying over to conventional mortgages.

Despite the lower risk of default for conventional mortgages, several 2nd tier lenders are being forced to sell them at higher rates.

Why?

The answer is largely due to CMHC’s new bulk insurance limits.

Many smaller lenders are unable to portfolio (i.e., hold on balance sheet) the mortgages they originate. Instead, they must sell off those mortgages to investors. Investors’ appetite is generally greatest for CMHC-insured mortgages—due to the risk mitigation of CMHC’s 100% government guarantee. Diminished availability of CMHC insurance on conventional mortgages means higher funding costs for those mortgages.

Fortunately, one capital markets expert we spoke with suggested investors may start warming up to CMHC-alternatives.

“I think more mortgage aggregators (institutional mortgage buyers) will look at increasing their respective exposures to the private insurers,” he told us.

If so, that would be a pleasant development for insurers Genworth and Canada Guaranty, and for the lenders increasingly relying on them.

In the meantime, until one of the following happens:

• liquidity premiums diminish for privately-insured (or uninsured) conventional mortgages, or
• CMHC bulk insurance becomes more widely available again,

…conventional funding costs may remain elevated relative to high-ratio funding costs.

The net effect in that case is that many smaller lenders may not be able to price as aggressively on mortgages with 20%+ equity. How counter-intuitive is that?

Rob McLister, CMT

Last modified: April 29, 2014