Sunday, April 17, 2011

Toward a "Subprime" Reset Chart for Canada

During the U.S. housing downturn the subprime reset chart was a much referenced tool for scoping out the future pain of overburdened homeowners. See example.

Canada badly lacks one of these. It also lacks a definition for "subprime". If there's one thing I love, it's a wide open field. The blank page is my favorite canvas.

But enough about me. Let's take a stab at a subprime reset chart.
Canadian "Subprime" Reset Chart - 35 and 40 year amortization renewals

I started with the CAAMP Surveys. These provide some nice information, such as: what percent of mortgages had activity, what percent were new originations, refinances and renewals. What percent were 35 year and 40 year amortizations. BUT (big caveat) this is survey data, not reality. For example, from what I can suss out, if you estimate the total mortgage debt based on the surveys you'll fall about 200 billion short of reality. But this kind of error means we're safe making some estimates from the surveys as they apparently underestimate mortgage debt.

I then turned to the Canadian Bankers Association Total Mortgages in Arrears to determine what basis to use for the percents from the CAAMP surveys.

Problem 1, CAAMP did not have lines on their survey in 2006 for 35 and 40 year amortizations (understandably, as who in the world would have imagined that). Also the survey was compiled before the change in insurance offerings, in any event. So I would have to guess at the numbers and I decided for this version to just leave it off. (More on how this might be estimated later.)

Problem 2, I don't know how many mortgages were closed/finalized each year. So the basis for the mortgage origination is simply the increase in the total number of mortgages from January to January when in theory some 1/25-1/30 of them were actually discharged that year and were replaced with new mortgages in the tally. (I decided this was minor given the other estimates going on.) But it might be causing a significant underestimation of the totals on the chart. Version 2.0 will make an attempt to address this.

Problem 3, I don't know whether the distribution of terms (1 year vs. 5 year vs. 7 year) is consistent across amortization schedules. I assumed it was. The percents used are:  1yr: 9%, 2yr: 5%, 3yr: 10%, 4yr: 5%, 5yr: 62%, 6yr: 4%, 7yr: 3%, 10yr: 2%.

Problem 1 Redux, Even though 35 and 40 year options was missing from the survey in 2006, some % (30% or so) have already been "reset" and are included in that more recent year's survey, so not all are missing.

Problem 4, The biggest estimation in this chart is the number of mortgages refinanced is computed from the CAAMP survey ratio of refinances to new originations multiplied against CBA reported total additional mortgages (computation as described in Problem 2).

What is "subprime"?

"Subprime" here has been defined here as any mortgage in excess of 30 years amortization. Why? Because anyone in a 35 or 40 year amortized mortgage is paying so little principal that to a first order approximation they are in an interest-only mortgage, and come reset time, it is definitely going to feel like an interest-only mortgage, depending on interest rates. Amortizations this long would not generally be considered the bastion of budget-wise households with a lot of extra monthly cash to spare, it strongly implies households that are stretching to meet affordability requirements. I'm sure some of these mortgages were issued to households who are highly responsible with their payments, are living well below their means, and just want payment flexibility, and 10 months out of 12 are actually making payments as if the mortgages are 15 year amortizations, but I'm willing to bet they are a small minority.


After making the estimates I went back to the CAAMP survey for 2010 and looked at the total percentage of renewals that year for 35 year and 40 year amortization mortgages. My estimates were 2% and .5% for 35 and 40 year respectively. The CAAMP survey indicated 5% and 3% respectively. Part of that shortfall in the chart are the missing data from 2006, part is possibly underestimation caused by using the survey data, as well as failing to take annual mortgage discharges into account. But, given that the numbers in the chart are lower than the only thing I could find to validate, I don't believe the chart is overestimating the situation. But the chart is still just that, an estimation.

This shortfall from the renewal numbers could be used to estimate 2006's 35 and 40 year amortization originations in a second version of the chart.

In Conclusion
Yes, this chart has flaws, but there isn't any other. If anything, I hope publishing a chart based on insufficient data will spur CMHC to issue an official one. This data should be public.


jesse said...

You're defining "subprime" as long amortization lengths? I think subprime may be correlated with longer ams but the two are not the same: a prime borrower can reasonably take out a 40 year term.

The data are additionally confusing because lines of credit (HELOCs) have made up 20%+ of credit growth in the past few years. Many are on revolving variable rates and, if prices fall, can be subject to being called if equity is reduced below 20%: the borrower must refi into an amortizing product and buy mortgage insurance as well. The "renewal gap" -- the difference in various rates a borrower faces on renewal will be negative for some time, with the exception of the variable rate loans.

In Canada rate are still way below their long-term average; that will provide juice for a while.

GG said...

I put subprime in quotes because it's not an official designation. Without access to credit scores and financial statements of borrowers there's no way to sort out which is which. In my thinking, only the minority of those planning to actually pay off their mortgage will take out a 40 year amortization. It's just a brutal payment schedule. It sounds like a flipper mortgage.

Many are on revolving variable rates and, if prices fall, can be subject to being called if equity is reduced below 20%: the borrower must refi into an amortizing product and buy mortgage insurance as well.

This sounds like a time bomb given that even if the rates are still favorable, the borrower might need to bring cash, and if they already have a HELOC, that probably was their source of cash. One of the lessons from the U.S. would be: don't expect banks to stick to convention, they will push the rules to benefit themselves more than expected.
5 year bond rates are creeping up.

jesse said...

In Canada, starting today, there is no government-backed mortgage insurance on any non-amortizing loans.

On the rate subject, I do not see much in the way of substantial private investment going on in developing countries -- much of the boom in China has been in the form of government-induced construction lending which is far from productive. The item developed-world CBs are keeping an eye on are positive real rates and by all indications even the developing world rates are still accommodative. As of right now it looks "choppy" though I'm loath to bet against Bill Gross and GS.

GG said...

>As of right now it looks "choppy" though I'm loath to bet against Bill Gross and GS.

Yeah, what does it say that that feels like betting against the printing press itself?

Unknown said...

My husband and I have a 40 yr amortization on a variable rate mortgage. (PRIME +1.3%) The 5 yr. renewal is coming up Dec. 1st. The bank is calling asking if we've decided what we're doing. Shouldn't the payments and rates just continue
unless we call them???? We are not selling, have no credit issues, pay more on our mortgage than required.
THe banks nose is out of joint because they aren't making much on it? Are they going to try to sabotage us in some way... the mortage guy at the bank said... "well we don't even sell that anymore" Are we under any obligation to renogiate anything?

GG said...

Planet28, I strongly suggest you post your question over at the McLister blog:
(use the contact us form)

This is their area.

This is a good question that is going to come up for a lot of people. The general understanding is that if you want the next mortgage to be 35 years you have to accept your current bank's terms. If you want to change banks you aren't going to get any shorter than 30 years. BUT, this is really an untested guess as to how things are going to be handled.

jesse said...

If the mortgage loan is insured as "high ratio" the bank will almost definitely be able to continue because they are 100% hedged. If they secured Genworth financing it's 90% counterparty hedged so (though I don't know for sure) I'm guessing they might be trying to lighten their exposure.

If the loan is low ratio there is nothing to state they need to continue business with you. They may have taken out "bulk" MI on your loan and if that avenue isn't available they might be trying to lighten their exposure.

Few lenders offer 35 year amortizations any more, I think you can find a few. But OTOH the rate you are going to be getting is probably close to 2% less than what you got previous. You can probably decrease your amortization to 30 years and maintain current payments, that will give you more options to shop around. And yes GG's right I would ask someone who can try get you a good rate elsewhere if you don't have the time/ability to do it yourself. My 2 cents