How an obscure budget change could raise mortgage rates
The acronym “ABCP” doesn’t come to mind when people go mortgage shopping. But if you get a new mortgage in the next few years, it could very well affect your interest rate.
ABCP stands for asset backed commercial paper. It’s used by a handful of non-bank lenders to raise capital for mortgage lending. ABCP got a bad name when it froze up on investors during the credit crunch of 2007-2008. Today, it’s a safer and fully restructured market.
Having access to ABCP lets smaller lendersreduce their overall funding costs. That helps them offer better mortgage rates to you and me. In turn, those lower rates force the major banks to be more competitive.
The role of small “wholesale” lenders, which sell mortgages mainly through brokers, cannot be underestimated. When people see a broker offer a great rate from one of these lenders, they either choose that lender and rate – or they ask a big bank to match it. That ecosystem keeps mortgage costs significantly lower than if small lenders did not exist.
But the future of ABCP and other private mortgage securitization techniques is now in question, at least as a way to fund insured mortgages. The federal budget, released in March, plans to prohibit lenders from selling insured mortgages to investors through any securitization method that is not managed by federally-run Canada Mortgage and Housing Corp . (CMHC).
That bombshell came “without any warning and without any consultation,” said Stephen Smith, president of the largest non-bank lender, First National. Speaking at the National Bank Canadian Financial Services Conference, Mr. Smith said the “collateral damage” to ABCP and smaller lenders “was not fully considered” by government officials.
In the last few weeks, I’ve heard some interesting theories behind the Finance Department’s motives. Some speculate that the government wants to earn more guarantee fees (by forcing lenders to use more CMHC-run mortgage backed securities as opposed to using private Canadian or U.S.-based securitizers). Other conspiracy theorists suggest that Ottawa wants to strengthen banks’ competitive position relative to their non-federally regulated competitors. But these aren’t Ottawa’s primary motivations.
In a statement, a Department of Finance official explained the government’s reasoning as follows:
“The Government is making these changes to increase market discipline in residential lending and reduce taxpayer exposure to the housing sector. Funding channels that use taxpayer-backed insured mortgages should be subject to minimum standards and Canadian oversight in order to promote financial stability.”
In other words, Ottawa wants to reduce risk by controlling securitization and controlling the mortgage assets on banks’ balance sheets. That’s understandable from a regulator’s standpoint, except for one thing: the mortgages are already insured before they go into ABCP, so the main taxpayer risk is already taken. This policy won’t reduce mortgage insurance volumes to any significant degree. Moreover, it won’t improve the credit quality of the borrowers who are insured.
What the new rules really do is force lenders to sell their mortgages in the specific method dictated by Ottawa, as opposed to potentially lower cost private securitization. That’s a problem because, for technical reasons, many low-risk mortgages simply don’t qualify for standard CMHC-backed securitization programs. The net effect is that shutting off all private securitization options raises costs and makes millions of insured borrowers pay more.
Today, this isn’t a huge worry because only $6-billion of insured mortgages are funded using ABCP. That’s a drop in the bucket given that roughly $200-billion in mortgages close every year. But the market could feel the effects down the road.
In the last six months, $2.3-billion of new ABCP programs have come online, says rating agency DBRS. Moreover, whereas four years ago there were no issuers of insured mortgage-backed ABCP, today there are 11. So the market is slowly starting to catch its stride - or at least it was until this latest in a string of new mortgage regulations.
But there is some room for optimism. The Finance Department says “The Government will consult with industry stakeholders” before implementing new rules. So perhaps there’s a chance it will see the negative effects on mortgage competition and alter its decision.
In the meantime, one can argue that slightly higher mortgage rates aren’t a big sacrifice if it means keeping the Canadian housing market sound and stable. The question is whether the remote risks being targeted by Ottawa truly justify yet another new cost to mortgage consumers.
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