Ottawa — The Globe and Mail Thursday, Mar. 21 2013
Finance Minister Jim Flaherty is stepping into Canada’s mortgage insurance market once again.
In the federal budget tabled Thursday, Ottawa announced further steps to limit taxpayers’ exposure to the mortgage market by cracking down on banks’ ability to use bulk mortgage insurance as a tool to offset their risks and boost their bottom lines
The move is the latest indication of Mr. Flaherty’s concerns the housing market may be overheating as Canadians continue to pile on debt while taking advantage of low interest rates. Earlier this week he criticized a mortgage-rate cut by Manulife Bank – which the lender quickly reversed – a controversial decision that has drawn much criticism from business people and politicians alike. Bank of Montreal kicked off the controversy at the beginning of the month when it announced a 2.99-per-cent rate, which Mr. Flaherty publicly rebuked.
While home sales have slowed significantly and prices in some markets have started to drop since Ottawa took steps to cool the market last summer, Mr. Flaherty continues to fret about the health of the residential real estate market, which many economists say remains overvalued.
As the economy returns to health and interest rates eventually rise, economists worry about consumers’ ability to meet their mortgage payments. Because Ottawa backstops mortgage insurance, Canadian taxpayers are highly exposed to the market.
Banks’ appetite for bulk mortgage insurance, also known as portfolio insurance, has grown markedly in recent years and is one of the factors behind the ballooning of government-owned Canada Mortgage and Housing Corp.’s balance sheet.
Any time a consumer buys a house with a down-payment of less than 20 per cent, the mortgage must be insured. But bulk insurance enables the banks to insure large swaths, or portfolios, of mortgages that don’t require insurance.
Banks started buying more bulk insurance during the financial crisis because it makes it easier for them to package their mortgages into securities, which ultimately helps them to lend more. But they’ve also been upping their purchases because by insuring mortgages they can reduce the amount of capital they’re required to hold.
Ottawa has been concerned about the growth of mortgage insurance for some time. Last year it capped the total amount of mortgage insurance that CMHC can have in force at $600-billion. As a result, CMHC, which was already creeping up toward that level, began rationing its sale of bulk insurance while maintaining sales levels of standard mortgage insurance (that on loans to borrowers with small down-payments).
Mortgage insurance ultimately compensates the bank or lender for losses from consumer defaults. It was originally intended as a way of making it easier for consumers with low down-payments to enter the housing market, by ensuring lenders they would be compensated for losses. But it has increasingly become a tool for banks to more broadly manage their risks, with mortgages being the largest piece of their consumer lending businesses.
“With the financial crisis well behind us, the government is amending the rules for portfolio insurance to increase market discipline in residential lending and reduce taxpayer exposure to the housing sector,” the budget states.
One of the new rules will gradually limit the sale of insurance on low loan-to-value mortgages (those where the consumer has a higher downpayment or equity) to those that are being used in a CMHC securitization program, such as Canada Mortgage Bonds. That will prevent banks from insuring large low-ratio portfolios just to hold onto them in order to reduce their capital requirements.
And Ottawa plans to stop the use of any taxpayer-backed insured mortgage (even high ratio) as collateral in securities that aren’t sponsored by CMHC. Volumes of such private-sector asset-backed securities were larger before the financial crisis, government officials indicated. But the move will limit Ottawa’s potential exposure as banks seek cheaper ways to fund their mortgage portfolios.
Ottawa said it intends to consult with the financial industry before implementing these new rules.
“Financial institutions will continue to have access to a broad array of financing options, including the recently implemented framework for covered bonds,” the budget states. The government said in that framework that it would not allow mortgages with government-backed insurance to be used in covered bonds.
To keep credit flowing at the height of the crisis in the fall of 2008, Mr. Flaherty stoked the mortgage market by announcing that Ottawa would essentially buy tens of billions of dollars worth of insured mortgages from the banks. The moves he’s making now go in the opposite direction.