For decades, most home loans made in Canada were made by the biggest banks and guaranteed by the government’s housing agency. In late 2016, regulators tightened the requirements for qualifying for that insurance, resulting in more people doing without it: about three-quarters of the mortgages made by federally regulated banks last year didn’t have government backing. Nearly half the nation’s $1.5 trillion of home loans are now uninsured.
For lenders, consumers’ growing demand for loans with no government backing creates a thorny problem: funding. A bank can easily bundle government-insured loans into bonds and sell them to investors. That bond market was $463 billion as of September 30.
Without that backing, banks and other lenders have to rely on deposits, asset-backed commercial paper, and other forms of funding that can be more expensive and less accessible, particularly for smaller firms. That’s why it could make sense for more lenders to package uninsured mortgages into bonds, which over time could become a cheaper and more reliable form of funding, said Moti Jungreis, head of global markets at Toronto-Dominion Bank’s TD Securities. He thinks an RMBS deal could be sold this year.
“The market has to come up with a solution,” he noted, as quoted by Bloomberg. “Otherwise there will be no financing available for mortgages.”
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Adding to this trouble, the federal government is worried about rising household debt levels for Canadians and nosebleed prices for homes. And regulators introduced rules effective January 1 that make it tougher for home-buyers to get a mortgage without government insurance from a federally regulated bank, further tightening access to home loans.
“I think the first bond sale past the post will have to be attractive to investors given the inherent risk with being close to the top of the market,” said Mark Carpani, a portfolio manager at Ridgewood Capital Asset Management in Toronto.
The biggest commercial banks can still sell securities known as covered bonds, which are backed by a pool of home loans that stay on the lender’s balance sheet. The most likely candidate to experiment with uninsured residential mortgage bonds would be smaller banks and finance companies known as “alternative mortgage lenders,” according to Jamie Feehely, a structured finance analyst with DBRS Ltd.
If prime mortgage rates rise another half or full percentage point from their current level of around 3.5%, which seems like a real possibility given expectations for central bank rate hikes, the securities would likely yield enough to entice investors, Feehely added.
Growth in the market for bonds backed by Canadian home loans without government insurance will likely take time as issuers and investors learn about the securities, said TD’s Jungreis.
“There’ll be a couple of deals and people will figure out what they want to get paid,” Jungreis said. “We think there’s an opportunity for us and the market, but it will have to evolve.”
The Canadian government is increasingly reluctant to insure mortgages against default. That may end up giving new life to a nascent bond market in the nation.