Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News
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Last week our federal government made another regulatory change as
part of its continuing effort to cool real estate markets across the
country. This latest tweak caps the amount of mortgage volume that CMHC
will guarantee for each lender under its National Housing Act
Mortgage-Backed Securities (NHA MBS) program.
First, a little
about the NHA MBS program, a somewhat complicated but hugely important
securitization vehicle, which has given large Canadian lenders a viable
alternative when they exceed their Canada Mortgage Bond (CMB) program
allocations.
The NHA MBS program is important because lending is a
spread business, meaning that lenders derive their profit from the
difference, or spread, between the rate they have to pay investors for
the use of their money and the rate of interest they charge borrowers
when they lend that same money out as mortgages. The cheaper a lender’s
cost of capital, the more flexibility they have either to book higher
profits or to pass on lower rates to borrowers.
Mortgages
that are sold into the NHA MBS program are secured against default by
the full faith and credit of our federal government, making them pretty
much bullet proof. As such, investors are willing to accept yields that
are lower than they would be without this guarantee.
Back to the
most recent change. The federal government (through CMHC) announced that
it is now limiting the dollar amount of new NHA MBS guarantees that it
will offer to each lender to $350 million this month. More importantly,
it has also made it clear that it will continue to enforce limits on
these guarantees in future.
Many lenders can fund their entire
mortgage portfolio under their Canada Mortgage Bond (CMB) program
allocation, a preferable alternative because using the CMB is cheaper
than funding mortgages through the NHA MBS program. But larger lenders
regularly exceed their CMB limits and since 2001, they have mostly
relied on the NHA MBS program when they run out of CMB room. As such,
this change will primarily impact Canada’s largest lenders who will now
have to incur higher funding costs when their NHA MBS allocations run
out. Since any alternative funding mechanisms will be more expensive, by
an estimated 0.20% to 0.30%, those costs may well be passed on to
end-consumers in the form of slightly higher mortgage rates.
Although
higher rates are never happy news in my business, I support this move.
The Bank of Canada (BoC) has long identified our rising household debt
levels as the greatest domestic threat to our economy and the federal
government has been trying to moderate our residential real estate
markets for years. Our choice is to either continue applying the
liquidity brakes until we engineer a controlled slowdown in real estate
price appreciation, or to ignore all warning signs and charge full steam
ahead while hoping for the best. We saw what ignorant bliss caused in
the US and I believe that our regulator is acting intelligently and
responsibly under our current market conditions.
When you think
about it, the NHA MBS program essentially gives large lenders a form of
government stimulus by lowering their cost of capital and increasing
their liquidity and it’s hard to argue that our real estate markets need
any more stimulus at this point. The NHA MBS program has already
doubled in size since the start of the financial crisis in 2007, so it’s
not as though our real estate markets haven’t benefitted from this
program. No long-term good could result from allowing this program to
continue growing exponentially. As I have written many times before when
supporting the federal government’s somewhat unpopular regulatory
changes, it is better to suffer some short-term pain to avoid a
longer-term crisis.
Two final thoughts about my support for this
change. First, since guarantees by the federal government are ultimately
backstopped by all Canadian taxpayers, the NHA MBS was really assigning
a risk to all Canadians in order to create a benefit (cheaper mortgage
rates) for only a subset of Canadians (home owners). Second, if lenders
are allowed to rely indefinitely on ironclad government protection
against credit losses, it’s easy to imagine that lenders might unduly
increase their tolerance for risk when they are placing an increasing
proportion of their bets with someone else’s money. This phenomenon is
commonly referred to as “moral hazard”. In that light, limiting the
future growth of the NHA MBS program seems to be an entirely reasonable
decision.
Now for some good news.
The BoC has consistently
warned that it would raise its overnight rate, on which variable-rate
mortgages are priced, to slow the rise in household borrowing levels. I
have long argued that this was an empty threat because it would inflict
too much collateral damage on other areas of our still fragile economy.
Instead, I predicted that our federal government would continue to apply
increased regulations.
This latest change provides further
confirmation that the BoC is unlikely to raise its overnight rate for
any reason other than that our economic fundamentals demand it. For
example, when we have 2%+ GDP growth, 2%+ inflation, consistent and
healthy job creation, etc.
Given the current state of our economy,
that day still appears to be a long way off and that is very good news
for variable-rate mortgage borrowers.
GoC five-year bond yields
rose one basis point last week, closing at 1.76% on Friday. The range of
available five-year fixed rates tightened a little as well, with most
offerings now between 3.29% and 3.39%. The federal government’s decision
to limit the growth of its NHA MBS in future will create higher costs
for some, but not all lenders. Given that, working with an independent
mortgage planner who has access to a wide range of lenders will help you
find the lenders who are least affected in the here and now by this
change.
Five-year variable-rate discounts shrank a little last
week, with the best available discount dropping from prime minus 0.60%
to prime minus 0.55% (which works out to 2.45% using today’s prime
rate). Despite this, I still believe that the variable rate is a
compelling option in today’s interest-rate environment, and on the
flipside, my best available five-year variable rate now comes with more
favourable terms and conditions (which you can read about in my latest Deal of the Week).
The Bottom Line:
The federal government’s decision to limit the growth of its NHA MBS
program will create slightly higher costs for some lenders but
nonetheless, is a prudent change designed to protect the long-term
stability of our real estate markets. This latest change also confirms
that our federal government believes that regulatory changes, not
tighter monetary policy by the BoC, are the best way to counteract the
housing-bubble risk, and as such, further reduces the risk that variable
rates will rise for the foreseeable future.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave
