CMHC Alludes to More Changes

The quest to trim government exposure to mortgage risk continues. In a speech Friday, CMHC head Evan Siddall said the country’s No. 1 default insurer may start offloading some risk to lenders.

“…We are evaluating a range of ideas on future improvements to our housing finance system,” he said, “including risk-sharing with lenders to further confront moral hazard, future sandbox changes if housing markets are to become less stable, and increased capital requirements.”

That may mean that CMHC will eventually make lenders pay a deductible on their default insurance claims.

If such a system were implemented, it would naturally trigger the question of benefit versus cost. And the answer to that question is debatable at best.

The benefits of a deductible system are clear. Lenders would underwrite slightly more conservatively, reducing potential defaults.

The downsides are just as clear. Lender costs, especially those of smaller lenders, would climb due to the deductible and due to a resulting increase in funding costs. This latter effect would stem from mortgage investors assigning new risk premiums to insured mortgages, since they would now be relying partly on the lender’s own credit worthiness (as opposed to just the government’s and/or insurer’s). Lenders’ funding costs would also likely increase as a result of higher regulatory capital requirements.

If lenders passed those added costs to consumers, as is foreseeable, Canadians would immediately pay more for mortgages. Rates could conceivably rise 10-20 basis points or more, sucking thousands of dollars from the pockets of Canadian families. That, of course, must be weighed against the reduced risk of a housing crash.

“…The greatest store of personal wealth in Canada is residential real estate,” Siddall said. But with mortgage lenders already exhaustively regulated and arrears just 11 basis points from the all-time low, it’s fair to wonder if CMHC has a fix looking for a problem.

CMHC is eyeing these changes with as much concern for its future housing exposure as for its present exposure. The reason government backs housing finance is to “assume the tail risk,” explained Siddall. For this role, taxpayers have been compensated “to the tune of $18 billion in profits from CMHC” since 2004.

In his speech he added: “…I am pleased to report that our stress testing confirms that CMHC would survive a 2008-2009 U.S.-type housing and financial crisis, if that were to occur in Canada.” That implies Canada’s current system is strong enough to withstand a 33% national price collapse. In the U.S. crisis, this was combined with default rates approaching double digits on insured mortgages, a fate barely in the realm of possibility north of the 49th.

CMHC says it’s keeping a close eye on the heartbeat of our housing market by watching for

  • overheating of demand in the housing market;
  • acceleration in house prices;
  • overvaluation in house prices; and
  • over-building in the housing market.

“As a risk manager…we aren’t overly worried about a housing bubble at this point in time, based on what we know.” Yet if “price growth remains strong or accelerates…we may need to look to macro-prudential counter-weights to avoid excesses,” he warned. “As I said, we are currently evaluating them.”

That may rattle mortgage industry executives, but Federal Finance Minister Joe Oliver has assured markets that these are longer-term initiatives (see this Bloomberg story).

“We’re looking at things, but we’re not going to be doing anything dramatic,” Oliver told Bloomberg. “We don’t see the need for it…You don’t want to cause the very thing you are trying to prevent.”

Rob McLister, CMT


  1. We had a deal approved at Equitable for a client with very little provable income, all ready to close. Problem is a bank lender comes along and all of a sudden we lose the deal.

    IF a big bank lender is underwriting deals with one hand covering part of the total risk, they are just cheating. The banks talk about fraud, yet they look at only half the picture and offer many undeserving borrowers “AAA” mortgage pricing..

    A deductible along with a refusal by CMHC to not pay a default claim for poor underwriting practices is long overdue.

    As an independent I welcome better underwriting practices, because sometimes it seems to me that there are two levels of underwriting;
    1. For the independents that need NOAs to prove income
    2. For the big banks that waive NOAs for undeserving borrowers.

    Let’s level the playing field for all, is my hope.

    1. “a refusal by CMHC to not pay a default claim for poor underwriting practices is long overdue”

      I’ve seen them deny claims for poor underwriting practices. No doubt they could tighten their scrutiny of said practices, but default claims don’t get an automatic free pass.

  2. Great article Rob,

    Especially like the “A fix looking for a problem” statement. Too many articles are written about the god awful risk CMHC’s insurance poses to the Canadian Taxpayer. 0.29% in arrears against 4,636,780 insured mortgages as of June this year. Note that is arrears not total default.

    18 BILLION in profits since 2004!!

    Yep, that’s a problem that needs fixing.

    My fear is the government is getting ready to re- structure the CMHC business model with the intent of selling the cash cow. Wouldn’t RBC, BOM, TD and/or CIBC love to get their hands on that baby.

  3. Rob hits the nail on the head, the deductible is not going to effect the defaulting borrower, period. Those folks will never pay the deducible, the point of any deductible in the insurance business is to motivate client behavior, well, that does not apply in this case. If you think the lender will end up paying the deductible, think again, the lender will pass the cost on to all lender customers in the form of higher rates. If you think it will turn the lenders into better underwriters, that’s just silly; all the lenders, banks or monolines underwrite the heck out of hi-ratio deals so that is not a factor. No, deductibles on mortgage insurance just enhance mortgage insurer net revenue. When the words “moral hazard” come out of a government appointee’s mouth check that you still have your wallet in your pocket because it is code for the public paying for something dressed up as something else.

  4. Thanks John & Ron,

    It’s become fashionable for commentators to toss around catchphrases like “moral hazard.” Yet, perhaps less than 1 in 10 such critics truly understand what motivates lenders, and what lenders have on the line if they violate sound lending principles. Regulators, analysts, insurers, funders and investors are crawling over lenders, monitoring them, auditing them, dissecting their books and just waiting for the smallest of red flags. A deductible will change little from a market risk standpoint because:

    a) it doesn’t mitigate the biggest default drivers of all, each of which crop up after closing: unemployment, stagnant wage growth, surging interest rates, debt accumulation, illness, divorce, etc., and because,

    b) lending guidelines in 2014 are as conservative as they have been in years, and they already reasonably factor in the above risks.

    Again, would the market be safer with a deductible? Unequivocally. That’s not the question. The relevant questions at this point are. “How much safer, and at what cost?”

    1. I completely agree that the term “moral hazard” has been bandied about rather haphazardly of late with regards to CMHC, and incorrectly to boot. The correct terminology in economic terms is “subjective hazard.”

      Moral hazard involves policies such as proposing to blow $75B on new fighter jets in order to make war.

  5. All this de-risking is fine and dandy until rates jump a few points and qualification becomes too difficult. That is when overeager regulators will have to own what they’ve done.

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