Canada’s banking regulator is eyeing changes to the rules governing high-down-payment mortgages.Fred Lum/The Globe and Mail
Finance Minister Jim Flaherty has been concerned about the sale of 30-year uninsured mortgages because the risks from some of these loans are ultimately being transferred from banks to taxpayers – and that's part of the reason why the banking regulator is now weighing changes, sources say.
Mr. Flaherty has tightened the country's basic mortgage insurance rules four times since the financial crisis, most recently last July, in bids to stop consumers from taking on too much debt, to cool the housing market, and to protect government coffers. Mortgage insurance is mandatory when the borrower's down payment is less than 20 per cent (so called high loan-to-value mortgages) and Mr. Flaherty's changes, such as cutting the maximum length of an insured mortgage to 25 years, applied to such loans.
But those changes didn't apply to a second type of product that mortgage insurers sell, known as bulk or portfolio insurance. Banks can buy bulk insurance to cover large swaths, or portfolios, of mortgages with low loan-to-value ratios (high down payments) that weren't previously insured.
Thirty-year mortgages are eligible for bulk insurance.
Canada's banking regulator has disclosed that it is studying 30-year uninsured mortgages, and might propose changes. Banking sources say Mr. Flaherty has been concerned since late last year that banks were continuing to offer such loans. While mortgages with high down payments are less risky, longer amortizations add risk, and mean consumers are ultimately paying more interest.
About two-thirds of the residential mortgages in Canada are insured, according to National Bank analyst Peter Routledge. At the end of 2012 the two largest mortgage insurers, Canada Mortgage and Housing Corp. and Genworth Canada, had insurance on a combined $868-billion of residential mortgages, of which 60 per cent was basic mandatory insurance on high-ratio loans and 34 per cent, or about $295-billion, was bulk insurance, he said. (The balance is CMHC insurance on multi-unit residential buildings.)
Mr. Routledge said that the 30-year mortgages covered by portfolio insurance are not adding huge incremental risk as long as the housing market holds steady, but they do transfer longer-term risk from the banks to the mortgage insurers.
"If things really went bad and you had a national housing correction of 35 per cent peak-to-trough, that could start to lead to higher losses for 30-year mortgages (in which the borrower has a relatively high level of equity)," he said.
"CMHC got paid for taking that risk," he added. "Whether they got paid enough, we're going to find out."
Mr. Routledge added that Ottawa needs to be cautious because declining house prices typically lag declining house sales, as they did in the U.S. crisis. House sales have fallen significantly since Mr. Flaherty banned 30-year high-ratio mortgages in July. Cutting the maximum length of low-ratio mortgages could add to the declines.
Sources said that, with the exception of 30-year mortgages, banks are applying most of the restrictions that Mr. Flaherty has placed on high-ratio mortgages to low-ratio mortgages.
Longer amortizations mean lower monthly payments for consumers, but those consumers will pay more in interest over the life of the mortgage.
"There's not much difference between a 25– and 30-year amortization for a good credit risk," said Finn Poschmann, vice-president of research at the C.D. Howe Institute.
"If the 30-year or more amortization is there mostly to make the mortgage loan affordable to the borrower, then it involves more risk. If a lender is willing to take on that risk, owing primarily to the fact that portfolio insurance is available, the risk is socialized – and that is problematic."
Banks started buying more bulk insurance during the financial crisis because it makes it easier for them to package the mortgages off into securities, which ultimately reduces their funding costs and enables them to lend more.
They were also increasing their purchases because by insuring mortgages they can reduce the amount of capital that they have to hold.
CMHC, the Crown corporation at the heart of the country's mortgage market, is the largest seller of bulk insurance.
The government has taken steps to curb the sale of this product. Last year it capped the amount of total mortgage insurance that CMHC can have in force at $600-billion, a move that forced CMHC to ration its sales of bulk insurance to the banks. As a result, CMHC's sales of portfolio insurance in 2012 fell 78 per cent from 2011.
Mr. Flaherty went further in the federal budget in March, outlining new rules that will gradually limit the sale of insurance on low-ratio mortgages to those that are being used in a CMHC securitization program, such as Canada Mortgage Bonds. That will stop banks from insuring large low-ratio portfolios just to hold on to them in order to reduce their capital requirements.
In its annual report, released this month, CMHC said that its "portfolio insurance on low ratio mortgage loans with down payments of 20 per cent or more is not mandatory but supports mortgage funding in Canada by providing lenders with securitization-ready assets."
It added that it operates its mortgage loan insurance business on a commercial basis. "The premiums and fees collected and interest earned cover related claims and other expenses, as well as provide a reasonable return to the Government of Canada."