More on the New Bulk Insurance Restrictions

Budget 2013Last week’s federal budget included few mortgage changes. One exception was a new proposal to restrict the use of default insurance on low-ratio mortgages (i.e., those with 20% or more equity).

The Department of Finance says it will gradually prohibit lenders from bulk insuring low-ratio mortgages unless those mortgages are part of a CMHC-backed securitization program.

In addition, the government said it eventually intends to prohibit insured mortgages from being used in any non-CMHC sponsored securitization program.

Here’s what this may mean to borrowers and lenders…

OttawaWhy is the government limiting “bulk insurance?”

The Department of Finance ostensibly wants to:

  • Lower Ottawa’s exposure to “nonessential” mortgage insurance (which taxpayers guarantee)
  • Encourage lenders to assume more risk themselves when extending credit, instead of relying on mortgage insurance
  • Free up insurance availability (CMHC has a legislatively-capped $600 billion insurance limit and it’s running close to that limit now. Bulk insurance eats into that available capacity and is deemed less essential to the housing market than regular [a.k.a. flow] insurance.)
  • Encourage banks to keep more capital on hand by restricting their ability to “portfolio insure” large numbers of mortgages. (Thus far, banks have been able to minimize the capital they must post against mortgages simply by purchasing low-cost portfolio [i.e., bulk] insurance. That’s because bulk insurance makes those mortgages essentially “risk-free” from a capital ratio and regulator’s standpoint.)

funding-cost-impactWhat effects might this have?

Here are some of the possibilities:

  • First off, the cost of funding mortgages should rise as banks may need to:

(a)  raise additional capital to hold low-ratio mortgages on their balance sheet (given that they can no longer bulk insure as freely),

and/or

(b)  securitize a greater number of low-ratio mortgages. That would require banks to:

  • pay additional government application and guarantee fees (two basis points plus ~0.2% of the mortgage amount on a 5-year fixed), and
  • sell those mortgages into a higher-cost mortgage-backed securities (MBS) market
    (Securitizing via MBS may get more expensive since other lenders would be doing the same thing, thus raising the cost of “liquidity”)
  • Smaller non-bank lenders will have fewer securitization options (Insured mortgages won’t be allowed as collateral in non-CMHC sponsored securitization vehicles like asset-backed commercial paper [ABCP]. ABCP is a private funding option that’s made a comeback since the credit crisis.)
  • Higher funding costs could lead to slightly higher mortgage rates, to the extent that lenders pass along these costs to consumers.
  • Government risk exposure will drop slightly (Although, the odds of mass defaults on mortgages with 20% or more down are already exceptionally low.)
  • Bulk insurance restrictions could encourage more use of covered bonds (a securitization mechanism that Ottawa is trying to promote as a way to fund uninsured mortgages)

FAQs:

  • Why would Ottawa allow insured mortgages as collateral for securitization sponsored by CMHC, but not allow them in private securitization vehicles? The Department of Finance told CMT on Friday: “The Government is making these changes to increase market discipline in residential lending and reduce taxpayer exposure to the housing sector. Funding channels that use taxpayer-backed insured mortgages should be subject to minimum standards and Canadian oversight in order to promote financial stability.”
  • Do these new rules apply to mortgage insurance from all three insurers? Yes.

Stethoscope and Canadian dollarFeedback from Industry:

These are quotes from various top-level industry leaders, who spoke to CMT on condition of anonymity:

  • Capital markets expert: “Wider mortgage spreads would seem to be the most obvious impact. The ‘race to the bottom’ should stop now.”
  • Industry executive: “The impact on mortgage insurers is not significant as most portfolio insured loans have (already) been used in CMHC securitization programs…There could be some impact to the smaller specialty mortgage lenders, but I feel this will be addressed during the commentary period.”
  • Another industry executive: “I think this is the Department of Finance not trusting the banks. They already put the covered bond framework in place. Why else would they take this further step?”
  • Another capital markets pro:NHA MBS is now the only game in town (for bulk insured mortgages) and funding costs will reflect that…If you’re a little guy (i.e., small lender)…it’s going to cost you…You’re going to potentially have to put up more equity or find a balance sheet lender (to sell more of your mortgages to).”

The changes contemplated here are expected to occur slowly, and not before the government gets comment from various stakeholders.


Rob McLister, CMT

  1. These steps should have been taken months ago. Nearing the imposed cap of overall insurance has been a concern that I have brought up many times in the past, mostly to be quickly dismissed by other industry professionals as not necessary. There are not too many (none that I can think of) other business models that allow the business (the bank) to make billions in profit off the backs of those who assume nearly all their risk. Yes cost of borrowing will go up and yes monolines will be faced with hurdles. They will be short lived until the new “norm” is set. We may see some product changes and some lenders stay away from certain LTV (say 65-80 %) but the end result is going to be o.k.
    And if we are lucky this should help end the rate race. A 20 BPS across the board increase in rate will be a non-factor in lives of clients and Mortgage Brokers.

  2. I’m surprised it’s taken this long to pick on this item in the budget. You really underestimate the size of non-bank originated mortgages held in Canadian ABCP and the importance of ABCP to small lender funding. This change runs opposite to the governments stated goal. This will have a huge impact on the small lenders and little to no impact on the big 6 banks… mortgage rates go up and competition goes down.

  3. Hi Jim,
    Thanks for the note. Do you have figures on how much of the ~$70 billion in annual broker mortgages is funded through ABCP? Do you know which lenders are using it currently?

  4. “A 20 BPS across the board increase in rate will be a non-factor in lives of clients”
    Are you joking?? 20 bp is $2,600 more interest over five years on my $275,000 mortgage! Maybe you’re independently wealthy and $2,600 doesn’t mean much to you, but it damn well does to me and many others.

  5. I’m not sure of the exact figures. Based on rating agency reports in January 2013 there was $26 billion in ABCP. Of that 23% was insured residential mortgages, another 23% HELOCs (the insured split is not clear) and only 4.5% conventional mortgages. The big banks are not funding their mortgages in the ABCP market, there are too many other cheap sources of funding for them.

  6. “Government risk exposure will drop slightly (Although, the odds of mass defaults on mortgages with 20% or more down are already exceptionally low.) ”
    Hi Rob,
    Assuming the low ratio bulk volume is replaced by high ratio flow volume, how is the govt’s risk exposure reduced? Or are you suggesting that flow volume would not be high enough to replace bulk volume, despite how tight they already are to the 600MM cap?
    Thanks.

  7. What risk? The risk of a 75% LTV prime mortgage going in arrears? That risk is negligible and taxpayers get paid very well for assuming it. The whole bulk insurance risk debate is totally overblown.

  8. Monthly payment differences on your mortgage amount is $28. If you purchased your exact home instead of another because of $28 then you would be the only person I know to have done so. Sure it correlates to $2600 interest over 5 years and that is significant, but it will mean nothing to the end result of getting a mortgage. If I told you your payment was $28 higher and was going to cost $520 extra interest per year to get a mortgage today than yesterday (when yesterday’s rate is no longer available to you) (today’s new norm) I am positive you would not blink an eye. At the end of the day you would not have a choice, much like you have no choice but to take a 25 year amortization instead of 30, which by the way has had an effect to both the client and the Broker. So to my point, I think the potential extra cost of borrowing due to this announcement is a non-factor.
    As for brokers the 20BPS will have zero change to business. No one is any busier today at 2.79% than a few days back at 2.99%, if they are it is because they have gotten better and gotten in front of more people. Many Brokers are selling 10 year product, some 80-100 BPS higher than these rates. Proof that the rate is insignificant.
    Refinances have almost vanished, and purchases year over year are down significantly almost everywhere in Canada. The historical low interest rates have done little to yield greater activity, they have contributed to house prices staying up for as long as they have and that is a much larger factor for people not entering the housing market.
    Just another change in the long list of changes over the past 36 months, I guess we will see how it plays out.

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