Canada's banks brace for mortgage overhaul

TheGlobeandMail.com
Oct. 3, 2016
By David Berman

The Canadian government is responding to widespread concerns about the country’s housing market by introducing sweeping policy changes that will upend the way banks grant mortgages and assess the risks associated with them.

Lenders will have to run stress tests on all new insured mortgages to ensure that borrowers can meet their debt obligations even if interest rates rise. But the biggest change is one that is still in the works: Finance Minister Bill Morneau said Ottawa will take a closer look at what is known as “lender risk-sharing” - which is the idea that the banks could have to pay a deductible on mortgage insurance provided by Canada Mortgage and Housing Corp. (CMHC) and its private sector competitors. Such a change would likely force banks to hold additional capital against mortgages, raising their funding costs. The banks would likely pass the new costs to consumers in the form of higher mortgage rates.

“This is a potential policy option that would require mortgage lenders to manage a portion of loan losses on insured mortgages that default, rather than transferring virtually all the risk onto the taxpayer via the government guarantee for mortgage insurers,” Mr. Morneau said. The government’s latest housing policy update, the second within the past 10 months, follows rising concern among a number of observers who believe that the real estate markets in Vancouver and Toronto are overheating.

While this is a problem for consumers living in these markets, it has also become a potential economic concern as well, given the risks associated with a market downturn.

None of Canada’s five biggest banks responded to a request for comment. However, the Canadian Bankers Association expressed concerns about the government’s proposal.

“The introduction of lender risk-sharing through a deductible on mortgage insurance would represent a significant structural change to the current housing finance system,” the CBA said in a statement.

It added: “We have concerns that it could have negative side effects on a housing finance system that has worked smoothly, simply and efficiently and served Canada’s economy well.”

The International Monetary Fund and the Organization for Economic Co-operation and Development have previously urged Canada to incorporate policies used in other countries, where lenders typically shoulder a substantial portion of losses on insured mortgages when the homeowner defaults.

Canadian banks, however, have typically resisted this blanket approach to change, preferring instead approaches that target specific urban markets. Brian Porter, chief executive officer of Bank of Nova Scotia, suggested earlier this year measures such as raising down payments, increasing the qualifying rate for five-year fixed mortgages and imposing a temporary luxury tax on foreign buyers.

On Monday, Mr. Morneau said the Department of Finance will hold consultations on lender risk-sharing with market participants this fall. “The government is taking a long-term view of the way the mortgage market functions,” he said.

In December, he doubled the minimum down payment for some home buyers and increased the fees charged to lenders that securitize government-backed mortgages.

Peter Routledge, an analyst at National Bank Financial with a keen interest in the risks associated with Canada’s housing market, said lender risk-sharing would represent a substantial shift in the way the system works.

“I would characterize it as a fundamentally different idea at the heart of mortgage insurance,” he said. Yet, he believes that if the government goes ahead with the changes, it would implement them slowly, perhaps starting with a risk-sharing threshold of just 5 per cent to 10 per cent on defaulted mortgages to see how the market reacts.

“The last thing they want is to do something disruptive to the housing market,” Mr. Routledge said.

Despite the concerns about the risks in Canada’s housing market, defaults are relatively rare right now. The CBA said that just 0.28 per cent of mortgages are in arrears.

Canadian banks have also suggested that they are comfortable with their mortgage books in Vancouver.

“We feel really quite good about our growth in that market,” David Williamson, group head of retail and business banking at Canadian Imperial Bank of Commerce, said after the lender reported its fiscal third-quarter results in August.

Laura Dottori-Attanasio, CIBC’s chief risk officer, added that the delinquency rates in Vancouver are lower than the national average.