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More Bad News for Small Lenders: Update 2

Since 2008, the Finance Department has announced one mortgage restriction after another, largely in an effort to wean lenders from government support. And just when you think there’s no more regulations to come, they tighten further.

The latest such measure came last week. On December 1, CMHC announced hefty fee hikes for guaranteeing mortgage-backed securities (MBS). And these are no piddly fee hikes. We’re talking 50-200% increases for government guarantees of MBS, and a 100% increase for Canada Mortgage Bond guarantees. That’s material given that roughly one-third of mortgages are funded by securitization.

Here’s why the powers that be are doing it, and what it could mean to mortgage consumers:

“This fee increase will narrow the funding cost difference between government-sponsored and private market funding sources,” says CMHC spokesperson Charles Sauriol, “thus encouraging the development of private market funding alternatives.”

In essence, Ottawa is making lenders pay more to have the government backstop their securitized mortgages. (Securitized mortgages are essentially big batches of mortgages sold to investors.)


Some lenders will pay much more than others. The main players in the securitization game are the Big 5 banks and “mortgage aggregators” like Merrill Lynch. These behemoths issue over $6 billion of MBS annually (Merrill excepted), a threshold that will now force them to pay double the fee of smaller players.

This two-tiered fee approach is meant to “better manage the demand for NHA MBS,” says Sauriol. “The lower guarantee fee for guarantees below the [$6 billion] threshold will ensure that adequate and cost-effective funding is still made available to support competition in the mortgage market.”

But civil servants don’t always foresee the ripple effects of such policies. Industry execs that we’ve talked to expect aggregators to instantly pass along these fees to their small lender customers.

Only select lenders who directly issue less than $6 billion in market MBS (First National and MCAP, for example) escape the full brunt of this fee grab. Their government guarantee fees on a 5-year fixed mortgage would be only 30 basis points instead of 60 basis points for banks like RBC and TD.

“Even with the fee increase, NHA MBS and CMB funding costs remain competitive,” Sauriol adds. “Moreover, a stronger capital market ensures all lenders have access to stable funding during economic downturns and market fluctuations.”

The question remains, however, how well would the private securitization system keep functioning in another credit crunch? It didn’t fare so well in the last one (anyone remember the ABCP crisis?).

Realistically, how long will it take for private securitization channels to replace the current system? Some insiders think a decade or more. Most private markets today (e.g., private trusts) are illiquid. On top of that, lenders will soon be prohibited from putting insured mortgages into private securitization pools (unless Ottawa relents on this rule).

In short, private funding markets are currently completely uncompetitive from a funding cost standpoint. So small players who underwrite quality mortgages will suffer. Those smaller guys, by the way, are lenders that the Federal government has pledged to support in its mission to create consumer choice and competition.

The most successful channel for uninsured mortgages is the covered bond market. Unfortunately, covered bonds are practical only for Canada’s largest and most creditworthy lenders. And even covered bonds are restricted to a minuscule 4% of the lender’s assets.

So will CMHC’s move slow the MBS market and put momentum behind private alternatives? Likely not anytime soon. “In my honest opinion the cost to take the insurance at these new levels for the Big Banks is still…attractive/negligible against what they are getting (in terms of funding cost),” said one bank funder we spoke with. “The fee increase…is likely to hit a smaller player that only has the CMB as its funding outlet…” And there are countless small lenders who fit that bill.

Many of these secondary lenders add critical competition that forces major banks to price more aggressively, saving consumers hundreds of millions each year in aggregate. CMHC’s new fees will disproportionately raise costs to most bank challengers. (Banks have various other funding avenues besides government-backed securitization, meaning they can better absorb higher fees on their own mortgage business.)

One lender says this move could force them to price up to 0.10 percentage points higher on 5-year fixed and variable rates, other things equal (that is a high estimate says CMHC). Ten basis points would be as much as $1,200 more in interest that a consumer could pay over five years on a $250,000 mortgage, depending on the lender. (Update from original story: CMHC says the rate impact would be 2.5 to 4.0 bps if the fees were fully passed on to the lender.)

It all boils down to higher costs for consumers and probably minimal reduction in MBS volumes. Taxpayer exposure to government-backed MBS won’t change in any meaningful way. (MBS, by the way, are comprised of insured mortgages that are already government-backed.) So what’s the point?

Perhaps more revenue for our friends in Ottawa.

Chart source: Torys