Shadow lenders take on risk in housing market
Canadians still chasing housing dream
Mortgage broker Samantha Brookes is trying to figure out how to get one of her clients out of a housing-fuelled debt hole.
The couple, a 59-year-old Toronto city worker and her husband, 58, have so much debt that they stopped making payments on the $410,000 mortgage for their suburban home. They wanted to refinance but regulations imposed last year will disqualify them. In a few weeks, they won’t even qualify for an uninsured loan at an alternative lender as more rules come into effect.
They opted for a third route: adding a second mortgage with an interest rate of 10.5 per cent to pay off their debt. Their salvation came from a private unregulated lender, a move many other Canadians are making as the government tries to rein in a home-price surge that’s driven household debt to a record. But like a giant game of Whac-A-Mole, the risk to the financial system from tapped out borrowers is merely shifting — this time to a market where there’s no oversight from the country’s national bank regulator and new stress-test rules don’t apply.
“We’re transferring risk from the regulated segment to the unregulated segment of the market,” said Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce. “If we have a significant correction, clearly the unregulated markets will suffer even more because that’s where the first casualties would be. And then you will see it elsewhere.”
Brookes says more than 90 per cent of her business in the last two months has been lining up funding from nonbank and private sources, or shadow banks — versus a 50-50 mix previously. “People aren’t going to stop buying, they’ll just find different ways of doing it.”
For the government, it may be a case of careful what you wish for. Anxious to prevent a repeat of the kind of taxpayer-funded bank bailouts that occurred in the United States after its housing crash a decade ago, the federal government has been moving to reduce its exposure to the mortgage-insurance market.
Rules last year added a stress test for insured loans backed by the government. That sent more buyers to the uninsured space, where a 20 per cent down payment is required. As of Jan. 1, these borrowers will also need to qualify at a rate two percentage points higher than their offered rate, a move which could lower mortgage creation by as much as 15 per cent, Canada’s bank regulator has said.
Earlier changes have already had a dramatic effect. Uninsured mortgages made up about threequarters of new loans at federally regulated banks this year, up from two-thirds in 2014, according to the Bank of Canada. Roughly 90 per cent of new mortgages in Toronto and Vancouver this year are now uninsured, in part because government insurance is forbidden on homes priced over $1 million and prices have risen, the bank said.
On the one hand, taxpayer risk has dropped as insured mortgage origination fell 17 per cent in the second quarter compared with a year earlier, the bank said in its semi-annual financial system review. About 49 per cent of all outstanding mortgages are now uninsured, up from 36 per cent five years ago. The credit quality of some of the loans at the big banks has also improved as borrowers buy less expensive homes, the Bank of Canada said.
The rules, along with other measures such as a foreign-purchase tax, have had an initial bite — with Toronto house prices falling 8.8 per cent from May to November and the average price of a home posting the first drop since 2009. Vancouver prices have reclaimed new heights after cooling earlier this year.
But the risks to the financial system haven’t gone away. In the uninsured space, mortgages are increasingly going to highly indebted households and for amortizations for longer than 25 years, the central bank said. And like Brookes’s clients drowning in house debt, more borrowers are turning to lenders whose
activities fall outside federal regulatory scope.
These include credit unions and mortgage-investment corporations, pools of money from individual shareholders, which aren’t subject to the new rules, Tal said. Credit unions hold about 17 per cent of uninsured mortgages, according to the Bank of Canada.
Canada’s patchwork regulatory system also doesn’t encourage comfort, Tal said. Banks are regulated by the Office of the Superintendent of Financial Institutions, but credit unions and brokerages are overseen provincially. Mortgage-finance companies are semi-regulated, and mortgage-investment corporations and other private lenders are unregulated.
Mortgage-investment corporations currently make up about 10 per cent of mortgage transaction volume, or six per cent of dollar volume, according to research from Tal at CIBC said. Transaction volume will likely grow to about 14 per cent under the new rules, and in the event of defaults in a housing correction, those mortgage-investment corporation investors would be open to losses, he said.
“Anything over 10 per cent is suboptimal,” he said. “You don’t want this market to be too big because you don’t want to increase the blind spots.”
Sound underwriting is an important element in maintaining a strong and stable Canadian financial system and OSFI will continue to monitor the country’s housing and mortgage markets under the new rules, said Annik Faucher, spokesperson for the Ottawa-based organization.
Like her clients, Brookes said borrowers will get creative to get around the new rules. Options include companies such as Alta West Capital, Fisgard Asset Management Corp. and Brookstreet Mortgage Investment Corp. or just a wealthy individual willing to lend at interest rates starting around 12 per cent.
Chuck McKitrick, CEO at Calgary-based Alta West said mortgage-investment corporations are regulated by the country’s securities commissions and various real estate bodies.
“We’re scrutinized a hundred different ways,” said McKitrick. “There’s very little difference between us and other regulated entities.”
Despite the expectation that mortgage-investment corporations will see more business, McKitrick said the big financial institutions will adapt to new regulations to keep lending. Shawn Stillman, a mortgage broker at Mortgage Outlet Inc., said banks could lower their mortgage rates so homebuyers would still qualify under the new stress-test rules.
“The bank doesn’t care because they’re still going to make their fees and get their money,” Stillman said.