Canadian housing prices are higher than levels consistent with current fundamentals in some provinces. The empirical estimates suggest that a 10 percent decline in housing prices would lead to a 1¼ percent decline in private consumption. The high level of household leverage and housing prices could prove to be a source of vulnerability. The rebound in debt and housing prices after the crisis largely reflects the resilience of the financial system and the stronger economic recovery in Canada, as well as historically low interest rates.

Abstract

Canadian housing prices are higher than levels consistent with current fundamentals in some provinces. The empirical estimates suggest that a 10 percent decline in housing prices would lead to a 1¼ percent decline in private consumption. The high level of household leverage and housing prices could prove to be a source of vulnerability. The rebound in debt and housing prices after the crisis largely reflects the resilience of the financial system and the stronger economic recovery in Canada, as well as historically low interest rates.

II. The Role of the CMHC in the Canadian Mortgage Market1

The Canadian housing market has experienced a boom over the last decade with increased mortgage credit and mortgage securitization. The Canada Mortgage and Housing Corporation (CMHC), a Crown corporation, plays a central role in the mortgage market insuring loans and guaranteeing the main securitization channels. This paper gives an overview of the main characteristics of the Canadian mortgage market with a focus on the role of the CMHC.

A. Introduction

1. Over the last decade, homeownership has increased by nearly four percent in Canada, with a booming mortgage market leading also to an increase in the size and role of the CMHC. As of 2010, the homeownership rate in Canada is estimated to be just under 70 percent. The booming house prices and homeownership rate have led to an increase in the residential assets of Canadian households, which grew in real terms at a yearly average of more than 7 percent between 2000 and 2010. In parallel, mortgage liabilities grew at an average rate of around 8 percent over the same period. The outstanding value of residential mortgages estimated at around C$1 trillion.2 Against this backdrop, CMHC has seen a substantial increase in its activity and size—its assets increased more than twelve-fold between 2000 and 2010, and it is currently one of the largest financial institutions in Canada.

B. overview of the Mortgage Market

2. Key features of the standard Canadian mortgage contract are the short mortgage term, refinancing penalties, and the full recourse on the mortgage loan in most provinces. The typical Canadian mortgage has a fixed rate (currently, around 68 percent of mortgages), a five-year term (borrowers can renegotiate their mortgage at the end of the 5-year term), and an amortization period of 25 years. The short term of the mortgage could be a result of federal regulation giving homeowners the right to prepay mortgages with a term to maturity greater than five years after five years of payments for a fixed prepayment penalty (see Kiff (2009)).3, 4 Unlike in the U.S., Canadian borrowers typically have to pay a penalty to prepay their loans.5 Mortgage loans are full recourse loans in Canada, meaning that the borrower remains responsible for the full amount of the mortgage even in the case of foreclosure. It is argued that the ability of banks to pursue other assets by the borrower and garnish their future wages has kept delinquency rates in check even during episodes of house price declines.

Figure 1.
Figure 1.

Canada: Overview of the Mortgage Market

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A002

Sources: Canada Bankers’ Association, Canadian Mortgage and Housing Corporation, Genworth, Haver Analytics, Statistics Canada, and Fund staff calculations.

3. Due to regulatory requirements and capital incentives, banks insure a significant share of their mortgage loans. Federal legislation requires all federally-regulated lenders to insure the residential mortgage loans they originate with a loan-to-value ratio (LTV) of more than 80 percent. Federally-regulated Canadian deposit-taking institutions comprise the largest share of originations (including indirect originations through brokers). Overall, around 70 percent of mortgages in Canada are funded through deposits. Insurance on mortgage loans is purchased by the lender and passed on to borrower either as an upfront fee or as an add-on to the mortgage principal. Banks also insure loans below the 80 percent LTV threshold to reduce capital requirements and for securitization purposes. While uninsured mortgages with LTV less than 80 percent have a capital risk weight of 35 percent, CMHC-insured mortgages have a capital risk weight of zero and mortgages insured by private insurers have a slightly higher risk weight (5 percent in the case of Genworth, the main private insurer), given the 90 percent government guarantee for private insurers. Recent regulations have imposed new limits on amortization periods and loan-to-value ratios (LTV) on newly originated mortgages (Box 1). The combined “insurance in force” of the two main insurers, CMHC and the Genworth (around C$790 billion) covers nearly 75 percent of outstanding mortgages.

C. The Role of CMHC

4. CMHC is a Crown corporation wholly owned by the Canadian government that operates, among other activities, the largest mortgage insurance business in Canada. The CMHC’s liabilities constitute a direct and unconditional obligation of the government. It is mainly through the CMHC that the government implements its housing policies. The core activity of the CMHC is its mortgage insurance business, which is expected to be self-funded and operated on a commercial basis. Specifically, mortgage insurance is expected to be priced to cover potential mortgage defaults and to ensure a commercial rate of return. The amount of reserves is also expected to be determined on an actuarial basis. CMHC insures the lender against a mortgage default by the borrower. In the event of a default, the lender could force a foreclosure and sell the property. CMHC (like any other mortgage insurer in Canada) is required to pay the shortfall between the sale proceeds and the remaining loan amount, plus up to 18 months of accrued interest and other foreclosure-related costs. The CMHC accounts for about 70 percent of the mortgage insurance market. At the end of Q2 2011, CMHC’s total insurance-in-force amounted to C$536 billion, approximately half of the outstanding mortgage debt in Canada.6

uA02fig01

Insurance and Guarantees, 1997-2010

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 365; 10.5089/9781463929237.002.A002

Sources: Canada Mortgage and Housing Corporation and Fund staff calculations.

5. The CMHC is subject to government oversight; it has a well-defined (albeit complex) regulatory framework but is not currently subject to the same financial supervision as private mortgage insurers. The legislative framework governing the CMHC consists primarily of the Canada Mortgage and Housing Corporation Act, the National Housing Act (NHA) and the Financial Administration Act. The stewardship of the CMHC is the responsibility of the Board of Directors, comprising the Chairperson, the President and Chief Executive Officer of CMHC, and eight other directors appointed by the Minister designated for the purposes of the CMHC Act. The CMHC reports to Parliament through its responsible Minister (the Minister of Human Resources and Skills Development) and must submit an annual five-year corporate plan, recommended by its responsible minister and the Minister of Finance. While CMHC’s mortgage insurance forms the largest part of CMHC’s activities, CMHC is not supervised by the Office of the Superintendent of Financial Institutions (OSFI), unlike private mortgage insurers. Nevertheless, it sets a target of 200 percent of OSFI’s Minimum Capital Test (MCT) and reported, as of Q2 2011, capital holdings above that target. Furthermore, CMHC engages in regular dialogue with the Department of Finance and members of the Senior Advisory Committee which includes OSFI, the Bank of Canada, the Canada Deposit Insurance Corporation, and Financial Consumer Agency of Canada.

6. CMHC also plays an important role in the securitization market by facilitating an adequate supply of low-cost funding for mortgage lending. CMHC provides a guarantee of principal and interest payments on NHA Mortgage Backed-Securities (NHA-MBS) and Canada Mortgage Bonds (CMB)—the two main funding channels for mortgages in Canada.

  • The NHA-MBS program started in 1987. Under this program, approved issuers (e.g., banks, credit unions, and life insurance companies) assemble and administer a pool of mortgages and issue securities backed by these mortgage loans. The underlying mortgages have to be insured by CMHC or other CMHC-approved insurers. These securities are then sold to investors with a guarantee, provided by CMHC, on the timely payment of the principal and interest.7 As of Q2 2011, NHA-MBS outstanding stood at C$294 billion (27½ percent of outstanding mortgages).

  • Canada Mortgage Bond program: CMHC established the CMB program to complement the NHA-MBS program. Under the CMB program, a special purpose vehicle name the Canada Housing Trust (CHT) sells non-amortizing Canada Mortgage Bonds to investors and uses the proceeds to purchase NHA-MBSs. As of Q2 2011, total CMB outstanding was C$204 billion (69 percent of all NHA-MBS issues).

7. During the global financial crisis the Canadian government put in place a program to support the availability of mortgage credit though CMHC-managed purchases of NHA MBS. Under the Insured Mortgage Purchase Program (IMPP), created in October 2008, CMHC purchased $69 billion in NHA MBS, financed by a government loan. The program, which authorized purchases of up to $125 billion in MBS, expired in March 2010. Given that the program involved purchases of NHA-MBS, the underlying mortgage loans were already insured by CMHC or private insurers backed by the government. The bulk of the government loan to CMHC that financed these purchases is expected to be repaid by 2015.

Mortgage Regulations (as of April 18, 2011)

article image
Source: Canadian Authorities.
1

Prepared by Jihad Dagher.

2

The average Canadian home is more expensive than its U.S. counterpart and is estimated to be worth C$374,159 as of Q2 2011 (based on data from The Canadian Real Estate Association).

3

Kiff, John, 2009: “Canadian Mortgage Markets: Boring but Effective?,” IMF WP/09/130.

4

It is also argued that the popularity of five-year retail term deposits, which is due to the 5-year insurance limit by Canada Deposit Insurance Corporation, is also a factor as it gives incentives for banks to match the maturity of their assets and liabilities.

5

Borrowers have nevertheless the option to pay up to 10–20 percent of the outstanding mortgage balance, annually, without penalties.

6

According to CMHC, the average equity in their insured mortgage portfolio is 45 percent.

7

The CMHC’s guarantee fees are typically in the range of 2040 basis points.

Canada: Selected Issues Paper
Author: International Monetary Fund