Ottawa's mortgage aid may cost banks
At the height of the financial crisis last fall, when the credit markets seized up, Ottawa stepped up with a plan to help the banks raise cash cheaply and quickly.
The federal government's program to buy up to $125-billion in mortgages, called the Insured Mortgage Purchase Program (IMPP), worked brilliantly, and the country's banks weathered the crisis with few major problems and no taxpayer bailout. But some analysts are wondering whether banks have been too enthusiastic about selling their loans to Ottawa - with negative implications for their future profits.
Canada's banks have packaged up and sold about $275-billion worth of mortgages as securities backed by government programs, including the IMPP. That's roughly one-quarter of the total mortgages outstanding in the country, according to BMO Nesbitt Burns analyst Ian de Verteuil ,up sharply from about 15 per cent in 2006.
The programs have been widely praised for keeping mortgage rates low and the housing market humming. One economist has called them "wildly successful."
But they've also been a source of big gains in tough times for the banks. The major banks earned closed to $1-billion in such gains in the second quarter - about 15 per cent of their profits, Mr. de Verteuil calculates. Now, as credit conditions ease and pressure on banks' balance sheets diminishes, there is increased scrutiny of the side effects that come with these securitizations. As banks sell off more of their insured mortgages, they are weakening a pillar of their balance sheets. High-quality mortgages have typically been a strength for Canadian banks - especially compared with their U.S. peers, which have long been heavy users of securitization. With many of those loans now in Ottawa's hands, their remaining assets carry, on average, more risk.
"There are negative macro policy implications of the extremely high level of securitization of Canadian residential mortgages," Mr. de Verteuil and fellow analyst Atul Shah wrote in a recent report to clients. "There is little doubt that in a time of poor liquidity, it ensured mortgage credit continued to flow and that Canada's banks remained liquid," the BMO analysts wrote. But they cautioned: "We are concerned that we could be pushing this process too far." Insured mortgages now make up just 6 per cent of total assets held by Canadian banks, down from 10 per cent a decade ago, the analysts said.
However, it's expected that the pace of mortgage securitization will drop off in coming months as the cost of bank borrowing drops and institutions opt to keep more mortgage loans on their own books. BMO forecasts that profits on mortgage securitizations will drop to more normal levels of $100-:million to $200-million.
"As the cost of funding a bank falls, so too does the need to securitize mortgages," said Sumit Malhotra, who follows Canada's banks for Macquarie Capital Markets. While there are important safeguards in the Canadian system that distinguish it from its U.S. counterpart, securitization is considered a key ingredient in the decline in lending standards that led to the U.S. subprime mortgage crisis.
Certain characteristics of the Canadian mortgage market - such as the lack of tax deductibility on mortgage interest and the fact that the lender can go after a mortgage borrower's other assets and income - help keep default rates exceptionally low by international standards. As a result, banks have chosen to increase their mortgage portfolios during the past 15 years, at the expense of business and government lending.
From Tuesday's Globe and Mail Last updated on Wednesday, Jul. 08, 2009 10:06AM EDT
