So far, he’s been pretty close to the mark. In the three months ending September 30, CMHC’s insured-purchase volumes are down 6%. (That drop isn’t due entirely to the rule changes, however.)
To start with, CMHC-insured high-ratio refinances (those with less than 20% equity) have plunged 22% Y/Y. CMHC attributes this to government policies that “effectively eliminated the high-ratio refinance market.”
On top of that, CMHC says its “portfolio (insurance…a.k.a. bulk insurance) volumes were approximately 98% lower” in Q3. That’s a direct result of it limiting “access to its portfolio product.”
That’s had noticeable effects on small lenders. According to one executive we spoke with, lenders like his can buy only 20-30% of the CMHC bulk insurance it could purchase just one year ago. And the big banks are also restricted, having been capped at $1 billion annually. Compare that to the $17 billion worth that Scotiabank bought last December alone. (More on why this matters below…)
The $600B ceiling
In total, CMHC booked a whopping 37% less insurance last quarter. That’s 54,435 fewer housing units that were insured in just a 3-month period, quite a drop.
CMHC now has $575.8 billion of insurance outstanding, a number that’s held steady since Q2. This puts CMHC just 4% under its $600 billion government-imposed limit.
CMHC is surviving within this limit because: (a) it rations bulk insurance, (b) its guidelines are now tighter, and (c) borrowers are paying down their principal at a rate of $60-65 billion a year—which makes room for new insurance.
Had the government not imposed its new mortgage rules, some think CMHC might have bumped against its $600 billion limit next year. (Policy makers certainly gave that some thought when drafting the new mortgage restrictions.)
The last games in town
“Canada Guaranty remains a portfolio insurance provider for its customers and lending partners,” says its CEO Andy Charles.
When allocating bulk insurance to lenders, he adds: “We take an overall relationship approach that is based on both low- and high-ratio business.”
Genworth has a similar approach. It “selectively participates in portfolio insurance under [a] clearly defined risk appetite and disciplined pricing approach.” Genworth wrote $2.7 billion in bulk insurance last quarter with “solid pricing” and a target of “mid-teen ROEs.”
With bulk insurance as a carrot, private insurers will put a dent in CMHC’s market share. So, if Flaherty wants more insurance in the hands of the privates (as he suggests), that’s exactly what he’s going to get.
Unfortunately, the demise of CMHC bulk insurance has repercussions. It’s made life distinctly more challenging for monoline lenders who rely on securitization and don’t take deposits. (Remember, institutional investors usually don’t buy prime mortgages from smaller lenders, unless they’re insured. For many monolines, even their low-ratio mortgages must be insured.)
As a result, non-balance sheet lenders are now:
- Increasingly reliant on private insurers – Lenders needing more bulk insurance have been driven into the arms of Genworth and Canada Guaranty. And that insurance is being sold on the insurer’s terms, meaning a lender often has to commit to routing an equal or greater amount of flow insurance through that insurer. (And who can blame Genworth and Canada Guaranty for that?)
- Forced to upcharge borrowers – Certain lenders must now factor the added expense of flow insurance into their conventional-rate pricing models. They can no longer offer the best rates without passing along that insurance cost to consumers—especially on rental or stated income financing.
- More limited in their funding options – Investors often refuse to pay the same for a privately-insured mortgage as they would to buy a CMHC-insured mortgage. That limits the range of investors that monoline lenders can turn to. (Fortunately, the risk premium on privately-insured mortgages is now significantly less than it was following the liquidity crisis.)
Of course, when times get tougher for lenders, times get tougher for consumers. How so, you ask?
- The above liquidity constraints directly increase a small lender’s high-ratio funding costs.That’s a problem because second-tier lenders keep the big boys “honest” on pricing. Don’t forget, banks are generally best-price-matchers, not best-price-setters. When funding options dwindle, funding sources (many of which are banks) react to lender demand by raising prices. Small lenders are then forced to charge higher interest rates, which means banks don’t need to match rates as aggressively. It’s a cycle where consumers ultimately lose.
- Less CMHC bulk insurance means less liquidity for conventional mortgages, and thus higher rates.That’s true even though conventional borrowers put down more money and are supposed to be lower risk. (To outsiders, this inverse relationship between loan-to-value and rates is one of the biggest paradoxes in our business today.)
- Options for harder-to-securitize and higher risk prime mortgages – like rental and BFS applications – shrink considerably.
The mortgage business has shifted towards conventional lending where barriers to competition have risen (assuming you don’t have a big balance sheet, that is). But there’s a flicker of light at the end of the tunnel.
One lender executive we spoke with today says higher rates could eventually spark renewed interest in Canada’s asset-backed securitization market. “A 4% coupon would make (selling) uninsured conventional mortgages more viable,” he says. For consumers and mortgage originators, that could be a pleasant silver lining to higher interest rates.
Other CMHC numbers of note:
- CMHC’s average high-ratio mortgage balance is $176,838.
- The nation’s top insurer made $1.16 billion of profit in its first three quarters. It’s made $17 billion over the last decade.
- Year-to-date, its losses on claims are 5% below plan. Its arrears rate is 0.34% and trending lower.
- CMHC’s Canada Mortgage Bond (CMB) guarantees—which small lenders rely on—fell 7% Y/Y.
- That said, it guaranteed 37% more securitized mortgages overall—“driven by increased issuance of Market NHA Mortgage-Backed Securities (MBS)…”A side note: If you’re curious why MBS has grown so much, here’s what one lender told us:CMBs are basically pools of mortgages packaged into bonds, which are then sold to investors. Lenders who get their funding from the CMB market are required to replace these mortgages as borrowers pay them off. To fund these “replacement assets,” lenders have increasingly been using MBS. MBS funding is more costly than CMB funding, but lenders don’t have to worry about replacing mortgages like they do with CMBs.
Rob McLister, CMT