With household debt rising, government-backed mortgage oversight increases

OTTAWA – The federal government is increasing oversight of government-backed mortgages in Canada, while also shifting more of the risk for some financial transactions back to the banks.

Finance Minister Jim Flaherty tabled changes Thursday — previously signalled in the budget — that will place Canada’s Mortgage and Housing Corp. under the control of the federal financial regulator.

Flaherty told reporters that CMHC — which insures mortgages when homebuyers make a down payment of less than 20 per cent — has become a significant financial sector player in Canada, and it is appropriate that it meet the high standards of soundness demanded by the Office of the Superintendent of Financial Institutions.

“I’ve been concerned about CMHC for some time, in this sense, it’s become an important financial institution in Canada and it was not subject to the same supervision” as banks, he said.

The agency, which Flaherty noted was originally intended to assist social housing, has evolved into a key pillar of Canada’s overall housing market, providing government backing to lenders on so called high-leverage mortgages.

The guarantee, which essentially removes banks’ exposure, helped stabilize Canada’s housing market during the 2008-09 credit squeeze by encouraging banks to keep lending. But many believe it is now contributing to what have become overheated housing market conditions, sky-high home prices and record high household debt.

In December, the International Monetary Fund called for a review of the supervision of the CMHC with a view to strengthening its risk management on about $500 billion worth of insured mortgages.

The changes, contained in the budget implementation bill tabled Thursday morning, would mean CMHC will be subject to annual “stress tests” to ensure its financial soundness under extreme conditions.

The bill would also restrict banks from issuing bonds backed by pools of CMHC-insured mortgages — in essence, using Ottawa’s guarantee to make their instruments more attractive.

TD Bank chief economist Craig Alexander called the changes “appropriate” and minor “tweaks” to Canada’s financial regulations, particularly compared to the major overhaul occurring in the United States, where risky lending practices led to a housing market crash.

“This isn’t going to make a big difference to either the real estate market or Canadians,” he said. “Banks will continue to offer covered bonds, but they just won’t be able to use CMHC-insured products in those bonds.”

The changes in covered bonds will likely raise the cost of funding to the banks modestly, predicted analysts.

“I think it’s a great move. It will make some of the banks unhappy, but there’s a grandfathering clause and they have plenty of time to adjust,” said C.D. Howe Institute economist Finn Poschmann.

It fact, according to the DBRS rating agency, it may be a case of the cart before the horse. Anticipating the legislation, banks had significantly stepped up their issuance of covered bonds in the past few months, bringing the outstanding value to $63 billion in March from $50 billion in December.

“Given that several of the banks still have insured mortgages, DBRS believes some of the Canadian banks will continue to fund using these instruments before the bill receives royal assent,” the agency added.

In a statement, the Canadian Bankers Association said that the statutory protection puts them in a “better position to diversify their sources of funding because this legislative framework will increase investor interest in Canadian covered bonds.”

Flaherty and Bank of Canada governor Mark Carney have signalled for well over a year they are becoming increasingly uncomfortable with the level of lending and rising indebtedness. Household debt reached record levels of over 150 per cent of disposable income last year, close to the 160 per cent mark that preceded the housing collapse in the United States.

In addition, an influx of activity in the housing market has pushed home prices to what some economists have characterized as unsustainable levels.

This week, Carney said he has seen encouraging trends on the debt front. Although he expects household debt to keep rising, he said the pace of growth has slowed sharply and more new mortgages being taken out have been of the more predictable fixed-rate variety.

Flaherty said Thursday he remains concerned about the hot condo markets in Vancouver, Toronto and even Montreal, although he gave no indication he was ready to tighten mortgage rules a fourth time.

The new actions in Canada are incremental and should be seen in context of the aftermath of the financial crisis, said Alexander.

“We’ve tightened up mortgage rules three times in the last couple of years, OSFI has now released new draft mortgage guidelines and now we’re getting changes to the oversight of CMHC,” he explained.

“The changes we’re seeing is very much tweaking the system, and that contrasts with what we’re seeing in the United States where the financial system is experiencing dramatic and radical structural change.”