Tuesday, March 29, 2011

Mortgage Insurance Risks to the Canadian Taxpayer

CMHC is backed by the full credit of the Canadian taxpayer, but they are only 70% of the market.

What of the remaining 30% of the mortgage insurance market?
Rating Mortgage Insurance Companies in Canada
• The insurance company covers 100% of the loan plus accrued interest against loss by the lender if the
borrower defaults.
• To establish a degree of parity between the CMHC and private MI providers, the government of Canada
provides a 90% guarantee of private MI claims. This places the private and public sector mortgage insurers
on a more level playing field for the purposes of calculating a lender’s risk exposure to MI providers.

The tax payers are backing the vast bulk of all insured mortgages. One has to hope that the insurance companies are aggressive at put-backs. Moral hazard would suggest the banks are not being very careful with the mortgages they are issuing. Unfortunately, the precedent from the 2008 downturn is to turn CMHC into a bailout mechanism, rather than an instrument of fairness.

And it's not just high loan to value mortgages that are backed, it's also any mortgage that is destined for securitization.

From Inside CMHC from Canadian Mortgage Trends.com
Pierre: At the end of 2008, the percentage of insured mortgages outstanding, compared to residential mortgage credit outstanding, was estimated at 68%.

Noteworthy: A large percentage of insured mortgages are under 80% loan-to-value. That’s because many lenders use CMHC “portfolio insurance” (which provides the same default insurance coverage as for high ratio mortgages) to lower capital requirements and/or as a prerequisite to securitizing their mortgages
Unfortunately, I couldn't find any newer numbers than this.

I love in this interview how they say, oh well, all is good since we hold 2x the capital required by OSFI, but never actually say what that number is.

The Minimum Capital Test is here. Pages 35-41

Mortgage insurance margins range from $.10 to $1.10 on $100 of original mortgage amount with factors applied to these of .04 to 1.75. This supports the generally cited number of 1.5% or so. Minimum capital requirements vary by the portfolio the company is holding at any time.

Note: profits from CMHC all these years have been dividended back to the Canadian Government, i.e. the tax payers (except for 2008 when they held it back and built reserves instead). It's not like the potential capital they could have been holding vanished; it's been spent on other things. It's possible that if the mortgage insurance fee has been set properly, even if the capital requirements look thin, the tax payers will not end up in the red, overall, but they are acting as secondary insurers, whether they want to be or not. And in reality, mortgage insurance is just a tax since much of it goes on a pass thru to the government.


jesse said...

Interesting analysis. We know banks take portfolio insurance -- when the CMHC recently reduced amortization lengths from 35 to 30 years on insured loans, guess what the banks did with their conventional loans?

If you ask nicely they'll still give you 35, but you better be good for it :)

The CMHC has been a profit centre for the government and I found it particularly telling when they used that as an excuse for them to continue their operations, slyly hinting the government should come a-running if their capital is impaired as if it's some duty for shareholders to bail out an insolvent corporation. Yeah...

I see the big story with CMHC being, if Canada's housing market hits the skids, they will face a liquidity mismatch between the insurance payouts to policyholders (banks) and the asset. The notional amount of this delta is significant, and could well be more than the $10-20BB of capital they have available. Sound familiar? This is exactly the problem US insurers and GSEs faced in '08. In Canada's situation the government would have to step in with bridge financing, hopefully at a high interest rate, to allow CMHC to continue. In net CMHC will be out $10-20BB, in my estimate, but in the interim they need to borrow much more than this.

The other annoyance I have with CMHC is their insurance of investor and second-home properties, the same wrongheaded policy as FHA loans in the US. Why should a residential property investor receive a lower interest rate than a commercial investor? Or an investor in water/gas/electricity utilities? We know now they shouldn't.

jesse said...

@GG, out of curiosity, do you know how Australia's mortgages are financed? I'm not too familiar with the system, but the MI schemes in Oz are often touted as a good model for other countries to copy as a buyer-pay method of hedging lender risk.

I was always wondering, though, who's the ultimate counterparty in the various lending schemes? That is, if an MI firm goes insolvent, what happens? Are there implicit/explicit government backstops or is it just "TS" to MI firms' investors?

GG said...

I have not been able to find a good analysis on that, nor have I been able to piece together who the bag holders might be from scratch. I have some links bookmarked, let me see here...

What is currently Genworth, the largest MI, was formerly Housing Loans Insurance Corporation Limited (HLIC) which was bought by GE Capital in 1997, from the AU gov.

"The HLIC is Australia's largest provider of mortgage insurance, and while the Australian government will retain ownership of HLIC's insurance book, GE Capital will manage it. " -- from here

Genworth is now a global multinational, expanding rapidly into new markets. I'm not sure that makes them more stable, though. Like the fall of AIG, the reserve requirements tend to be by sector and country and not available to make good on other losses.

Genworth lost money 2010 Q4, but not on business in Canada or Australia, it seems. "At the same time, we are facing some growth headwinds. In Europe, consumer lending remains sluggish with few signs of improvement. In Australia, the high loan-to-value lending market has slowed significantly, but we expect improvement in 2011. While in Canada, we expect a modest decline in the 2011 market from strong levels seen during 2010. " -- from here

Actually, there are some interesting things in that transcript on foreclosures and souring mortgages if you have the time to slog through it. Also this: " In anticipation of further decline, we added an additional $200 million of reserves in the fourth quarter, for a total of the $350 million in reserve strengthening." Which looks like peanuts. Their profits also are not very high for their MI subsidiary in Sydney. In q3, they recorded 40 million net income on 110 million of revenue. These guys seem too small to matter (at least at a first glance), and if they are the largest, either the field is VERY wide or MI is not a big issue.

I did find this amusing:
"Did You Know Genworth have recently being approving mortgage insurance cover for applications which are declined by Commonwealth Bank (CBA) and Westpac.

What does this mean? Contact us to find out how this could benefit you. Don't rely on the decision of your own bank. Contact the right mortgage broker to discover your path through the ever changing banking landscape in Australia." -- from here

I meant to write a post about who the bagholders would be about 3 months ago, but there is too much to learn to even get started and there is that real job and all that...