Carney v. Banks

Mark-Carney Bank of Canada chief Mark Carney isn't afraid to confront Canada's financial titans. 

He aimed these comments in the big banks' direction yesterday:

"We expect our banks to make lending available, to have credit available and affordable in Canada. We're acquiring a lot of their mortgages … up to $75 billion worth. We've given a guarantee with respect to some of their obligations. So this is a two-way street. We expect credit to be available through our financial institutions." (Reuters)

Carney also had concerns about upcoming potential risks. According to CTV:

  • He feels household incomes could drop significantly. Vulnerable households could then default on loans causing significant losses for Canada's banks he says.
  • Carney also said that banks who hoard capital because they fear loan losses will worsen the situation.

Well, that doesn't exactly make banks want to lend. 

On the other hand, based on historical credit spreads, 5-year fixed rates should be in the low 3% range right now.  Instead they're close to 5%.  There is room to drop if lenders want to–on the fixed side at least.  A lot of people know that and they aren't happy that rates are being held up.

(On a related note, there's been a nice drop in the "TED spread" lately.  The TED spread is a good measure of perceived credit risk and it has been tracking mortgage rate premiums pretty closely…so down is good.)

Given all this, the big banks have increasingly been under the spotlight to loosen up lending.  Canadians can thank Mr. Carney for making the spotlight brighter.

10-Year Canada Mortgage Bonds

Canadian-Mortgage-BondsThe very first 10-year Canada Mortgage Bonds (CMBs) launched last Thursday.  As expected, investors ate them right up.

$2 billion worth of the 10-year notes were sold at a 4.11% yield.  That’s 0.73% above comparable government bonds.

Like regular 10-year Canadas, CMBs are also fully guaranteed by the Canadian government.  Their 0.73% premium over regular bonds is therefore one of the closest things to free money you’ll get in a government-backed bond.

This newest issuance continues to support Canada’s lending market.  While CMBs have been in existence since 2001, in the last year or so they’ve become an increasingly vital source of mortgage capital.  That’s because fear of mortgage defaults has chased many traditional mortgage investors into hiding.  The CMB program picks up some slack and provides sustaining capital to lenders who might otherwise have few other sources of funds.

The new 10-year CMBs join Canada Housing Trust’s existing 5-year and variable-rate issues.  Going forward, 10-year CMBs will likely be sold on a quarterly basis according to CMHC.

As 10-year CMBs attract a broader pool of investors, they will continue to provide much-needed capital to the mortgage market. That, of course, has a positive effect on interest rates for Canadian homeowners.

Ottawa to Buy More Mortgages

ottawa Mortgage lenders got another boost yesterday from the federal government.  The Finance Department announced it will now buy up to $75 billion of Canadian mortgages under it’s recently announced Insured Mortgage Purchase Program (IMPP).  Ottawa’s original pledge was $25 billion.

The Toronto Sun has a good explanation of the program:

Put simply, the government is selling bonds and treasury bills to raise cash and then giving that money to the Canada Mortgage and Housing Corp. — a Crown corporation — to buy mortgages from the bank. Homeowners still make their mortgage payments to the bank which then passes that money along to the CMHC for a service fee.

In other words, the government is buying mortgages from lenders so lenders can lend that money to the next guy–at decent interest rates.

All the mortgages being purchased are insured and considered “high-quality assets.”

The IMPP has been hugely popular with lenders thus far.  Banks have been pushing Ottawa to expand the program ever since it first launched.  The reason is simple.  Selling to the government is more profitable than selling to other investors.

Canadian-Mortgage-BondsAs a side note, before the IMPP came to town, most lenders were relying heavily on the Canadian Mortgage Bond (CMB) program.  The IMPP has essentially become a supplement to the CMB program.  (It’s different though because, under the IMPP, mortgages are purchased by CMHC itself and remain on CMHC’s books.)

Interestingly, most Canadians are oblivious to how vital Canada’s CMB program is these days.  The fact is, it’s exceedingly tough to securitize (re-sell) mortgages at good prices in our subprime-rattled market right now.  Without the CMB program, some lenders we know would probably not survive.  The government performs a critical service by supporting the securitization market with the Canadian Mortgage Bond.

Anyway, back on topic.  As most people know, money for mortgages has been scarce.  Because of this, mortgage rates have been higher than normal.  Finance Minister Jim Flaherty knows this and is concerned about how it’s affecting our economy.  In yesterday’s release he said: “The Government will not allow Canada’s financial system, which has been ranked as the soundest in the world, to be put at risk by global events.”

He said the IMPP will:

  1. “Provide Canada’s financial institutions with significant and stable access to longer-term funding,” and;
  2. “Earn a modest rate of return for the Government with no additional risk to the taxpayer.”

Point #2 is true enough.  The government will make $190 million on its first three IMPP purchases according to the Globe.  This profit comes from the difference between the interest the government earns on the mortgages it buys, and the interest it pays on the bonds it sells.  The Sun says:

Of the bonds sold yesterday, the government is paying out an average of 2.7% to the bond holder while collecting an average interest rate on the mortgages it buys, of 3.78%.

The Finance Department announced other liquidity enhancing initiatives as well.  One of them was to reduce the cost of government insurance on interbank loans.  (The original 1.85% premium was too high to begin with.)

Here’s more background information on all the government’s announcements yesterday.

In a nutshell, all of these efforts are geared to one thing: keeping money flowing and lenders lending.  In the short-term that’s a good thing for borrowers.  Then again, we haven’t seen mortgage rates come down very much since the IMPP first took effect.  Hopefully that changes in the near future.

CLAF

The acronym of the day:  CLAF.  It stands for Canadian Lenders Assurance Facility.  It's essentially loan insurance that the government has just created to guarantee credit among federally-regulated deposit-taking institutions. 

The goal of the CLAF is to encourage more lending in the midst of Canada's worst credit crisis in memory. 

The cost of the insurance isn't cheap, however.  It's 1.60%-1.85% of the loan amount.  As the government puts it, "it is being made available as a backstop in case conditions in global credit markets disrupt Canadian lenders’ access to the funds they need to keep lending."

Given the price, there's a fair chance it won't have any major uptake, or impact on reducing mortgage funding costs.  The CEO from low-cost lender ING was quoted by the Globe as saying, "Of the various options that we have to cost-effectively fund our business, this is not something we would probably be interested in."

The CLAF is totally voluntary and is set to expire next April 30.