Canada's largest banks are quietly embracing Ottawa's new mantra to share some risk in the country's mortgage system, a fundamental shift that would alter the way the country's $1.4-trillion mortgage market operates.
This week, federal Finance Minister Bill Morneau said he would begin discussions with the financial industry on a government plan to introduce risk-sharing into the taxpayer-backed insurance market that covers mortgages when the customer does not have a down payment of at least 20 per cent.
Canada is unique among advanced economies in that a large share of its mortgage market is covered by government-backed insurance, meaning taxpayers could have to cover the banks' losses for large-scale mortgage defaults during a housing crash. Risk-sharing would reduce the amount of public money that the Canada Mortgage and House Corp. and other institutions could have to pay to the lenders.
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Publicly, the banking community's message is that risk-sharing is unnecessary because there is no indication that a crisis would overwhelm the mortgage insurance system. They also say a change could severely damage the big banks' profits by forcing them to devote more capital to their mortgage portfolios. "We have concerns that it could have negative side effects on a housing finance system that has worked smoothly, simply and efficiently and served Canada's economy well," the Canadian Bankers Association said in a statement.
But in private, many banks have embraced the idea, according to conversations with people familiar with the evolution. "Philosophically, people aren't all that fussed," one executive said.
The banks' change of heart comes amid growing worries about elevated levels of household debt in Canada and soaring prices for homes in Toronto and Vancouver. "All lenders concern themselves when they see eye-watering [price] increases in urban markets," said John Webster, head of real-estate-secured lending at Bank of Nova Scotia, because they force buyers to borrow more.
The announcement from the Liberal government is a marked departure from the Conservative government's position that risk-sharing would be too "dramatic" a change to Canada's housing finance system.
Federal officials held informal talks with the financial industry on risk-sharing at the start of the year, but announced their intentions only this week. Ottawa now appears intent on enacting a plan to reduce taxpayers' exposure to the housing market, and make the banks pick up some of the slack.
Internal documents from the Department of Finance obtained by The Globe and Mail under Access to Information show that Ottawa has been considering a variety of approaches.
Government officials are studying three scenarios, according to the heavily redacted draft report of a meeting involving Finance officials in July, 2015. The first is a system where lenders would absorb a fixed percentage of the value of a defaulted loan, known as "first loss."
Another option is a "split loss," in which lenders pay a percentage of the total losses associated with a defaulted mortgage.
The third is "fee-based approach" in which insurers cover the full claim on mortgage defaults and charge lenders a fee. The fee option is one way the government has sought to address concerns that lender risk-sharing would affect CMHC's $426-billion mortgage-backed securities programs, which the government also guarantees.
The document also outlines "key considerations" the government is studying, including how risk-sharing might affect competition and pricing in the mortgage market, and capital requirements for lenders.
"We must recognize that lender risk sharing would represent a fundamental reorientation of Canada's housing finance framework, a framework that has served us very well for decades, with potential consequences that we need to fully understand," the document states.
The Department of Finance is set to release the consultation paper in coming weeks that will more directly detail how Ottawa hopes to implement risk-sharing in the mortgage market.
Finance officials declined to discuss the options until then. "It would be inappropriate to speculate on the content before the paper is released and accessible to all stakeholders," the department said in an e-mail.
Another proposal is putting a time limit on mortgage insurance. Currently, insurance backed by Ottawa lasts for a loan's entire lifetime – up to 25 years on new mortgages. One option is for government backing to end at a fixed point – maybe 15 years. That could reduce taxpayers' current exposure by 20 to 40 per cent.
As it stands, a large portion of the Big Six banks' portfolios of insured mortgages are deemed risk-free by the Office of the Superintendent of Financial Institutions, their federal watchdog. These comprise about 70 per cent of the total market, which means taxpayers are on the hook for a large share in the event of a decline in housing prices due to a recession. The CMHC and its two private sector competitors, Genworth and Canada Guaranty, have insured more than $900-billion worth of mortgage debt as of the second quarter.
In an interview Monday, Mr. Morneau said Ottawa is committed to a gradual and modest approach to moves that could disrupt the country's housing-finance system.
"Any changes we'll make will be in consultation with the financial institutions," he said. "But I think it would be fair to say that we think that we need to look at where the risk is placed in the market and do it in a way that acknowledges how well the market has worked, acknowledges how sound our housing market has been for the long-term and also recognizes that you've constantly got to stay on top of it."
Stuart Levings, CEO of Genworth, CMHC's the largest private-sector competitor, was not surprised the government is going ahead with formal consultations. But he said risk-sharing is not needed because current stringent regulations have kept mortgage defaults low and prevented the kind of bad loans that hurt the mortgage insurance industry. "There's nobody just throwing a loan at the wall and seeing if it sticks so to speak," he said.
People in the financial industry say Ottawa seems sincere about wanting a constructive dialogue rather than pushing a particular proposal, and that banks would not tolerate a heavy-handed shift in the mortgage market.
In the same way that they discourage sudden Bank of Canada interest rate hikes, they fear too strong an approach could harm the housing sector, which is crucial to the Canadian economy, and to the banks' and the governments' finances.
There is also still some frustration in the bank corner. The lenders have said they are willing to be proactive, but they still expect a bit of a game to be played before a final proposal is drafted, with each side staking out their territory. What's become clear, however, is that multiple proposals are floating around, many of which are much more nuanced than the widespread assumption that any risk sharing would come in the form of a deductible on mortgage insurance.
Mr. Levings has suggested to Ottawa that it implement a two-tiered system for risk-sharing, requiring a higher deductible for CMHC mortgage insurance than what lenders would pay if they insured their mortgages with the private sector. "That would automatically shift a little more risk over to the private sector," he said.
Still, he said, any shift toward risk-sharing might make lenders less likely to lend to home buyers in riskier housing markets such as remote and rural communities and those that are highly dependent on the fortunes of a single industry, such as oil or forestry.
"I don't think we've really put a lot more thought into what we would prefer to see," he said, "just because we're still hoping that this would never need to be done."
Tim Kiladze
Tamsin McMahon