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detailed

Canada’s banking regulator wants mortgage default insurers to put more money between themselves and taxpayers, especially for mortgages they insure in riskier cities.

The new rules, detailed today by OSFI, will force government-backed insurers to bolster their capital on mortgages in certain areas. Effective January 1, 2017, this could make mortgages more expensive for insurers and consumers alike.

“When house prices are high relative to borrower incomes, the new framework will require that more capital be set aside,” said Superintendent Jeremy Rudin.

In a report today, BMO Capital Markets referred to these changes as “modestly tougher capital requirements.” It said that “through a phase-in mechanism” the new rules “essentially apply to new business only.”

You can bet your last basis point that insurers are already looking at ways to offset these new costs. Borrowers could be stuck with steeper premiums, higher interest rates and/or more rigid underwriting. That’s especially true if they have:

  • Lower credit scores
  • Higher loan-to-values
  • Longer amortizations.

I’m hearing insiders speculate that this could even lead to regional premium variations. So I asked OSFI if it’s possible that a borrower in Toronto might be asked to pay a higher insurance premium than a borrower in, say, London, Ontario. OSFI replied: “It is up to the institutions to determine how they will manage the new requirements.”

As of Q2, Toronto, Vancouver, Edmonton and Calgary would have exceeded OSFI’s valuation thresholds and forced insurers to cough up more capital on mortgages in those cities. OSFI is using census metropolitan areas (CMAs) to define the regional boundaries.

Genworth Canada, the country’s largest private insurer, is already setting expectations for higher premiums. In a statement today it said:

The Company expects that the capital required for certain loan-to-value categories may increase and this could lead to a corresponding increase in premium rates. In addition, for those regions that are impacted by the supplementary capital, premium rates could also increase.

CMHC reviews premiums annually. We wouldn’t be surprised if it announces higher premiums by the first few months in 2017 or before.

Even premiums on low-ratio mortgages may rise. That could be a problem for certain monoline lenders who depend on buying transactional insurance to fund (securitize) their mortgages. More expensive low-ratio premiums could put them at a further competitive disadvantage to big banks that don’t rely on low-ratio transactional insurance.

OSFI confirmed for us that, “The same calculation formulas will be used for all mortgages whether insured individually or as part of a portfolio.”

Rising premiums aren’t the only fallout here. It could also get incrementally tougher for some borrowers to get an insured mortgage. Insurers may now try even harder not to incur losses on mortgages that entail higher capital costs. That could mean marginally more declines and fewer guideline exceptions.

In some cases, however, insured mortgages might actually require less capital than today. OSFI says, “All else being equal, the capital requirement for mortgages associated with borrowers with better credit, and that pay their mortgages off quickly, will be lower. Also, under the new framework, mortgage insurers will no longer have to hold capital for mortgages that have been fully paid off.”

OSFI’s proposed changes are up for public comment until October 21.

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Mortgage Market & MBS Nuggets

Securitization versus the U.S.

Risky mortgage securitization was blamed for feeding the U.S. housing crisis. In comparison, not only is Canadian MBS regulated far more rigidly than that toxic American MBS of old, but our overall securitization share of mortgage finance remains well below U.S. levels

MBS Outstanding

There are $440 billion of outstanding NHA MBS in Canada, all fully guaranteed by our government. NHA MBS benefits from Canada being one of only 10 countries in the world with a triple-A credit rating (Australia, Denmark, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden and Switzerland are the others).

Distribution of MBS

The majority of NHA MBS are held in Canada Mortgage Bonds (CMBs), of which there are $215 billion outstanding. Big 6 Banks hold another $172 billion of MBS, leaving roughly $39 billion in the hands of secondary investors.

Canada’s Banks are Titans

Canada’s major banks hold almost twice as much mortgage market share as do U.S. banks.

Regulatory Impact on Credit

Check out how CMHC’s average borrower profile has improved over the past year and a half, thanks in large part to the Department of Finance’s stricter lending policies.

anadian Versus U.S. Delinquencies

Total mortgage delinquencies in Canada have typically remained under 0.50%. Compare that to U.S. prime fixed-rate defaults, which soared to about 2.4% during the financial crisis. Over the past two decades, Canadian delinquencies have never surpassed 0.7%.

Canadian Versus U.S. Insurer Capitalization

CMHC’s insurance in force is $523 billion. Backing that is about $16 billion in capital, or 3%. By contrast, there’s “a congressionally mandated 2% capital target for the FHA in the US,” says BofAML, a capital level that must cover “an arguably weaker borrower credit profile.”