Since 2010 the Canadian government has introduced multiple changes to the country’s RMBS market, among them:
- Requiring borrowers to qualify for mortgages using the five-year fixed rate regardless of the mortgage term.
- Increasing the minimum down payment to 20% from 5% for investor-owned properties.
- Restricting the use of insured mortgages as collateral in registered covered bond programmes.
- Reducing the maximum amortisation term for insured mortgages to 25 years from 30 years.
- Reducing the maximum refinance amount to 80% from 85% of the property value.
- Eliminating mortgage insurance eligibility for properties over C$1m.
- Announcing a restriction on using insured mortgages as collateral in private-label RMBS and asset-backed commercial paper (ABCP) conduits.
- Increasing homeowner mortgage loan insurance premiums by approximately 15%.
The biggest question facing the market is regarding the future of RMBS that are backed by private, not government insured mortgages. “While banks have a diverse range of funding options for residential mortgages,” the S&P report noted, “including deposits and covered bond programmes, non-bank mortgage lenders have generally relied more on wholesale financing strategies, including ABCP warehousing and federal and provincial housing programmes.
“We believe that standalone, uninsured amortising term RMBS securitisations in Canada will be considered with increasing frequency in the near future.”
Most residential mortgages in Canada have a loan term of up to five years with a 25- to 30-year amortisation period. At the end of each loan term, the remaining principal balance is due as a balloon payment. This is generally paid by the lender renewing (i.e., rolling-over or extending) the mortgage for an additional term while maintaining the original amortisation schedule.
This need to continuously renew the loan poses unique challenges for the Canadian RMBS market, compared to other markets, including the US, where the mortgage terms extend to match the amortisation period. “The inability or unwillingness of an originator to renew could affect the securitised pool’s collateral performance and create event risk in the transaction, even with prime collateral,” according to S&P.
The Canadian housing market continues to be highly overvalued. Canada’s housing prices remain among the highest relative to income and rental costs compared with other major real estate markets around the world. According to the home price-to-income ratio, Canadian home prices may be 30% overvalued relative to their historical average between 1988 and 2013, up from 20% before the recession in 2008. “We continue to monitor the potential for a sharp housing price correction,” said S&P.
This overvaluation needs to be considered in the context of analyzing RMBS. “For example, under our criteria for rating UK RMBS, to maintain a relatively constant ‘AAA’ credit enhancement anchor during normal housing cycles, we adjust the loss coverage level by considering any deemed overvaluation or undervaluation in the market and the likely impact of volatile house prices on the property’s expected recovery value if a borrower defaults.”
While the presence of full recourse for many residential mortgages ameliorates that risk, historical experience demonstrates that as products and markets evolve, asset performance can become less predictable.
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