Sharing Mortgage Risk

Managing the MortgageWhen we apply for car insurance or for that matter any kind of insurance, there is a deductible for claims. Having seen this for a long time, I believed that this is a best practise in the industry. Today I learned that under our current system, the entire risk is shouldered by the mortgage insurer. OECD and IMF had previously urged Canada to follow the model used in other countries in which Mortgage insurers generally cover the first 10% to 30% of losses but require lenders to shoulder the rest.

Since taking over as CEO at CMHC in 2014, Evan Siddall has been working hard on his mandate and has taken measures to reduce tax holders exposure to mortgage risk given the frothy Canadian housing market. Just like banks work in the best interest of their share holders, CMHC is trying to work in best interest of its principals, the tax payers.

In the first quarter of 2014, CMHC introduced a risk fee on new and existing portfolio insurance as well as increased Insurance premiums for new single-family dwellings and 1-4 unit rental properties by 10 bps to 45 bps.

In the second quarter of 2014, CMHC announced the discontinuation of insurance on second homes.  Discontinuation of insurance on all individual low-ratio homes over $1 million and also the discontinuation of insurance on multi-unit condominium construction. All of these steps helped transformation of the risk profile at CMHC.

In the last quarter of 2014, CMHC introduced increase in fees charged to issuers of NHA MBS -(National Housing Act – Mortgage Backed Securities). To provide a quick background, understand that banks lend to home owners and create a CMHC insured mortgage, they sell it to the MBS trust. This gives the MBS Trust a right to collect mortgage payments and also to sell it to investors. These mortgages are now fully backed by CMHC insurance. If the mortgage holder does not make their regular payment, then the MBS Trust has to pay the investor and maintain the monthly payment schedule. CMHC mortgage insurance protects the MBS Trust.

Currently, banks do not have to hold any capital against the insured mortgage portfolio since these are considered risk free. If a deductible were to be introduced, the amount of the deductible would require capital backing because that portion is uninsured. This could also increase the mortgage rates because banks will pass it off to the customer (Tax payer). Another problem being reviewed is that if the MBS with deductible was sold, in the event of default, who will bear the deductible, will it be the original lender or the ultimate investor?

According to the news item, the banking industry feels that introduction of a deductible (lender risk sharing) would represent a significant structural change to the workings of the housing finance system and make it more complicated and uncertain. They also argue that the current system has worked well with prudent underwriting standards leaving just 0.28% of mortgages in arrears. Given that mortgages are a thin margin product, to them it makes good business sense to stay with the current system.

Now if we look at the banking industry in the last few years, we see significant job cuts (look at links at the bottom of this article). We also see increases in banking fees. Also under the current system, it would be possible for a bank to issue mortgage, sell it to MBS trust and lend again. The profits of all the big banks have risen significantly year over year and the CEO compensation has also maintained an upward trend. The banking industry is also supposed to be fighting to stay on top of the Fintech disruption that would cost money and more recruits.

If you look at the overall picture, banks have been cutting jobs to be more efficient and to defend and  boost the bottom line and protect the interest of their shareholders. The Bank CEO is rewarded for increasing the profitability in the midst of a struggling economy. The larger Canadian economy has been under performing. The tax payer base is reducing due to job cuts and people getting into self employment. In the past, housing prices were not so high. Now with the heightened risk in the housing market, CMHC wants to do its job of making sure that the lenders are responsible and protect exposure to taxpayer, where is the problem? Banks have handled more complex products and have always charged us deductibles. What is good for the goose has to be good for the gander. Keep it up Mr. Siddall.

A stable housing market is good for all and hopefully good sense will ensure that any objections to moderate the punch bowl is executed properly so that the economy can drive sober and arrive alive.

References:

Recent job cuts by the banks to respond to the market and protect their shareholders interest:

Bank of Montreal to cut more than 1,800 jobs | Globalnews.ca
Why Scotiabank is cutting jobs while earning billions: Don Pittis – CBC.ca
CIBC announces job cuts in wake of slower profit growth – The Globe …
TD latest bank to earn billions and dole out job cuts – Business – CBC …
RBC to shake up wealth division and cut jobs – The Globe and Mail

All about MBS

About the CMHC chief

Filed under:Complicated

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s