More on the New Bulk Insurance Restrictions- Consult with a Vancouver Mortgage Broker

Last week’s federal budget included few mortgage changes. One exception was a new proposal to restrict the use of default insurance on low-ratiomortgages (i.e., those with 20% or more equity).

The Department of Finance says it will gradually prohibit lenders from bulk insuring low-ratio mortgages unless those mortgages are part of a CMHC-backedsecuritization program.

In addition, the government said it eventually intends to prohibit insured mortgages from being used in any non-CMHC sponsored securitization program.

Here’s what this may mean to borrowers and lenders…

Why is the government limiting “bulk insurance?”

The Department of Finance ostensibly wants to:

• Lower Ottawa’s exposure to “nonessential” mortgage insurance (which taxpayers guarantee)
• Encourage lenders to assume more risk themselves when extending credit, instead of relying on mortgage insurance
• Free up insurance availability (CMHC has a legislatively-capped $600 billion insurance limit and it’s running close to that limit now. Bulk insurance eats into that available capacity and is deemed less essential to the housing market than regular [a.k.a. flow] insurance.)
• Encourage banks to keep more capital on hand by restricting their ability to “portfolio insure” large numbers of mortgages. (Thus far, banks have been able to minimize the capital they must post against mortgages simply by purchasing low-cost portfolio [i.e., bulk] insurance. That’s because bulk insurance makes those mortgages essentially “risk-free” from a capital ratio and regulator’s standpoint.)

What effects might this have?

Here are some of the possibilities:

• First off, the cost of funding mortgages should rise as banks may need to:

(a)  raise additional capital to hold low-ratio mortgages on their balance sheet (given that they can no longer bulk insure as freely), 

and/or

(b)  securitize a greater number of low-ratio mortgages. That would require banks to:

• pay additional government application and guarantee fees(two basis points plus ~0.2% of the mortgage amount on a 5-year fixed), and 
• sell those mortgages into a higher-cost mortgage-backed securities (MBS) market 
  (Securitizing via MBS may get more expensive since other lenders would be doing the same thing, thus raising the cost of “liquidity”)

• Smaller non-bank lenders will have fewer securitization options (Insured mortgages won’t be allowed as collateral in non-CMHC sponsored securitization vehicles like asset-backed commercial paper [ABCP]. ABCP is a private funding option that’s made a comeback since the credit crisis.)
• Higher funding costs could lead to slightly higher mortgage rates, to the extent that lenders pass along these costs to consumers.
• Government risk exposure will drop slightly (Although, the odds of mass defaults on mortgages with 20% or more down are already exceptionally low.)
• Bulk insurance restrictions could encourage more use of covered bonds (a securitization mechanism that Ottawa is trying to promote as a way to fund uninsured mortgages)

FAQs:

• Why would Ottawa allow insured mortgages as collateral for securitization sponsored byCMHC, but not allow them in privatesecuritization vehicles? The Department of Finance told CMT on Friday: “The Government is making these changes to increase market discipline in residential lending and reduce taxpayer exposure to the housing sector. Funding channels that use taxpayer-backed insured mortgages should be subject to minimum standards and Canadian oversight in order to promote financial stability.”
• Do these new rules apply to mortgage insurance from all three insurers? Yes.

Feedback from Industry:

These are quotes from various top-level industry leaders, who spoke to CMT on condition of anonymity:

• Capital markets expert:“Wider mortgage spreads would seem to be the most obvious impact. The ‘race to the bottom’ should stop now.”
• Industry executive: “The impact on mortgage insurers is not significant as most portfolio insured loans have (already) been used in CMHC securitization programs…There could be some impact to the smaller specialty mortgage lenders, but I feel this will be addressed during the commentary period.”
• Another industry executive: “I think this is the Department of Finance not trusting the banks. They already put the covered bond framework in place. Why else would they take this further step?”
• Another capital markets pro: “NHA MBS is now the only game in town (for bulk insured mortgages) and funding costs will reflect that…If you’re a little guy (i.e., small lender)…it’s going to cost you…You’re going to potentially have to put up more equity or find a balance sheet lender (to sell more of your mortgages to).”

The changes contemplated here are expected to occur slowly, and not before the government gets comment from various stakeholders.

Rob McLister, CMT