Ottawa's plan to clamp down on mortgage securitization will make it harder for smaller lenders to compete with big banks, increasing their costs – and potentially raising mortgage rates, players in the sector say.
Non-bank lenders and mortgage brokers have told Ottawa they are worried about the plan, which was first outlined in the federal budget less than two weeks ago. They fear the proposed changes will limit competition, distort mortgage rates, and throw a wrench in the recovery of the asset-backed commercial paper (ABCP) market.
"We're pleased that the government has indicated that they're willing to discuss potential implementation measures and what the effect might be on some non-bank lenders who are significant players in the residential mortgage market," said Jim Murphy, CEO of the Canadian Association of Accredited Mortgage Professionals. "Otherwise, we would have been very concerned that this would be implemented with unintended consequences."
The government has been seeking to constrict the mortgage market of late. Finance Minister Jim Flaherty has tightened mortgage insurance rules four times since 2008, each time making it somewhat more difficult to obtain a mortgage. And he has publicly expressed his concern over lenders competing with each other to drive down rates.
Banks traditionally used customer deposits to make loans, but feeding mortgages into securities is another way that both banks and other lenders obtain funds for mortgage lending. Ottawa said in the budget that it plans to prohibit taxpayer-backed insured mortgages being rolled into securities that aren't sponsored by Canada Mortgage and Housing Corp. (which sponsors Canada Mortgage Bonds and some other securities), implying insured mortgages will no longer be allowed in ABCP. Ottawa backs insured mortgages from CMHC and its private-sector competitors Genworth and Canada Guaranty.
Insured mortgages currently account for 23 per cent, or $6.3-billion, of the assets underlying ABCP, which is an important source of funds for First National Financial LP, MCAP Financial Corp., and Investors Group.
"This enables people like ourselves who are non-deposit-taking institutions to compete with the banks," said Stephen Smith, the co-founder and president of First National. Chartered banks account for about three-quarters of mortgages outstanding in Canada. "It maintains competition without the government taking on extra risk."
The changes come even as Ottawa says it wants to examine competition in the banking sector in order to make it easier for small players to enter and grow.
The government guarantees insured mortgages. Once the mortgages have been insured, taxpayers don't assume any additional risk by putting those mortgages into ABCP, Mr. Smith said.
First National wrote $11.3-billion worth of residential mortgages last year. It funds those through a variety of means, including so-called institutional placements – arrangements where First National continues to be the lender as far as the borrower is concerned but essentially offloads the mortgage to a big bank or other institution for a fee – as well as using ABCP and Canada Mortgage bonds.
Ottawa said in the budget that it will consult with the industry before implementing changes. "From my perspective, it's a rather sudden policy change and I think it will have a negative impact on the growth of the ABCP market in Canada," said Jamie Feehely, managing director at DBRS Ltd.
But Derek Norton, CEO of MCAP, said he believes that Ottawa is open to changes. "I think they haven't thought through all this. … There's a set of circumstances which would be quite painful for us and would make us less competitive than we are today, but I'm also told from a number of different sources that's not the intent."
Mr. Feehely and others suggested that more uninsured mortgages would wind up in ABCP as a result.
The ABCP market was worth about $122-billion before it was decimated by the credit crisis in 2007. Roughly $32-billion of the paper that was not sponsored by banks froze at that time, when buyers were scared away by fears about potential exposure to subprime mortgages. Investors were left in the lurch and the situation created massive headaches for Ottawa, banks that had sold the paper, and DBRS, which had rated it.
At the end of January, the market was worth $26.3-billion, excluding the paper that froze up, according to a recent report from DBRS. Auto-related loans made up nearly 30 per cent of the assets backing it and residential mortgages 28.5 per cent (23 per cent of the market is insured mortgages, 4.5 per cent uninsured). "The ABCP market continues to gain momentum," said the report, which was written prior to the budget.
"What happens between now and the final rule, is it just game on?" added Mr. Feehely. "Can issuers continue to add insured mortgage assets or is there a moratorium in place?"