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Impacts of Bulk Mortgage Insurance On The Canadian Mortgage Market
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August 7, 2012 @ 10:11 AM by: Jason De Lima
Posted in Why is it that your client, who has saved a 20% (or more) down payment for the purchase of a
home, seems to have fewer borrowing options that the first time buyer with only 5% down?
Why are many of the best lender special offers only applicable to high ratio mortgages? The
answer lies in mortgage default insurance (or the lack of it) and in who pays the insurance
premium.
When concerns arose earlier this year over CMHC quickly approaching its legislated limit of
total mortgage default insurance in force ($600 billion), portfolio or “bulk” insurance found
itself clearly in the cross-hairs (for reasons discussed below) and CMHC acted to restrict bulk
insurance volumes for lenders in order to preserve their ability to write standard (also known as
“flow”) mortgage default insurance policies. So, what is bulk insurance, why and where is it
used, why has it grown so quickly over the past couple of years and what impact does it have
on the Canadian mortgage market now and going forward?
Back to your client who has a 20% down payment. The good news for her is that she is not
required to purchase mortgage default insurance. Her 20% equity cushion (provided that she
meets other basic underwriting criteria) is deemed to be sufficient and she saves herself the
cost of the premium (which is almost always financed as part of the mortgage). Her mortgage is
a conventional, uninsured mortgage. As with any mortgage, her lender has a range of options in
terms of how to fund it: they can hold it on their own balance sheet or sell her loan to another
investor or to the capital markets through a securitization structure or an MBS. But her lender’s
options are more limited than they would be if her mortgage was insured. So, her lender may
choose to insure the mortgage anyway and pay the insurance premium itself. Why would they
consider this?
Lenders purchase bulk insurance for three main reasons: first, insured mortgages are simply
easier to sell to investors. If given the choice, an insured mortgage is, for any investor, a less
risky investment than an uninsured mortgage is – and the yields are generally equal. Most
securitization and MBS structures will only accept insured mortgages and most covered bond
programs (another way of selling mortgages to the capital markets) also use only insured
mortgages.The second reason is to gain capital relief. Canadian financial institutions are required to
maintain capital reserves to back-stop their loans. Insured mortgages (where credit losses are
covered through the insurance), for obvious reasons, carry lower capital requirements than
uninsured ones do. Lenders will of course crunch the numbers and compare the cost of bulk
insurance premiums to the cost of allocating capital to uninsured mortgages but capital is often
better deployed elsewhere, making bulk insurance premiums the cheaper alternative.
The third reason for insuring low loan-to-value mortgages is to reduce credit risk. For large
institutions like Canadian banks, this reason is much less relevant as they have strong
underwriting criteria and decades of experience in the performance of their loan portfolios. For
smaller lenders, there is value to them in moving credit risk out of their portfolios and it also
allows them to sell the assets more easily if they choose to do so.
When CMHC began to approach the $600 billion mortgage insurance limit, the rapid growth in
bulk insurance was seen as one of the main reasons. This recent spike resulted from the growth
in the use of covered bonds as a funding mechanism for banks (which usually require only
insured mortgages). When CMHC moved to restrict bulk insurance volumes, the two private
mortgage insurers in Canada, Genworth and Canada Guarantee, stood to benefit – as long as
investors were comfortable with a slightly reduced government guarantee.
CMHC’s liabilities are 100% guaranteed by the government of Canada – ie, Canadian taxpayers.
Private insurers enjoy only a 90% guarantee. During times of great economic uncertainty (like
2008 and 2009), investors preferred the full government guarantee and CMHC’s insurance
volumes soared at the expense of the private insurers. Investor appetite for mortgages insured
by one of the private insurers has returned and this is reflected in Genworth’s Q2 results which
were released last week.
In the second quarter of this year, of the $18.8 billion of new mortgage insurance issued by
Genworth, $13.1 billion was in the form of bulk insurance, representing nearly a 700% increase
over the same period in 2011. They clearly benefitted from CMHC’s pull back and are now
approaching their own limit of $250 billion in total insurance in force. This is expected to be
increased to $300 billion for both Genworth and Canada Guarantee by the end of this year.
The mortgage market seems to rely more and more on bulk insurance as lenders increasingly
choose strategies which move assets off their own balance sheets (by selling to investors or the
capital markets which desire or require insured only mortgages) or position themselves to do so
later if conditions warrant. When the concept of mortgage insurance was created, it was
intended for high ratio purchases for borrowers who had not saved the usual 20% or 25% down
payment. Conventional mortgages with significant borrower equity were seen as less risky.
Now, they require more capital to support them and they are seen as more difficult to sell.Private insurers have stepped in and filled the void created by CMHC’s pull back from bulk
insurance. If we enter another period of severe economic turmoil, private mortgage insurance,
with its 90% guarantee, may not be as easily saleable as it is now. What then? CMHC’s $600
billion limit could be increased but there are political reasons why this is unlikely. Otherwise,
your client who has saved their 20% down payment may need to invest some of her savings
elsewhere and get a high ratio mortgage instead. Their lender will be more than happy to lend
them the insurance premium which they will need to pay.
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