Mortgage lender Home Capital Group Inc. has priced its first offering of residential mortgage-backed securities, potentially marking an important step toward creating a viable private market for investing in pools of Canadian mortgages.
Home Capital is selling $425-million of securities comprised of uninsured, fixed-rate mortgages as part of a broader strategy to become less reliant on raising deposits to fund its loans. The lender suffered a liquidity crisis in 2017 after the Ontario Securities Commission alleged it had failed to properly disclose instances of mortgage fraud, which prompted a run on its deposits.
Mortgage-backed securities allow lenders to package loans and sell them to investors, then use the proceeds to issue more mortgages or invest in their businesses. While about 15 per cent of Canadian mortgage debt is pooled in government-backed mortgage securities, only insured loans are eligible. With uninsured mortgages becoming more common, Bank of Canada Governor Stephen Poloz called this year for lenders to develop a private market for residential mortgage-backed securities (RMBS), which could provide them with a new tool to fund some of their loans.
Home Capital is planning a sustained push into RMBS made up of uninsured loans, and this first issue could serve as a litmus test for investors’ appetite. If market conditions remain favourable, Home Capital would consider making follow-on offerings as often as twice a year, and RMBS could eventually provide as much as 10 per cent of its funding. Those new issues could serve as a cornerstone for a more robust and liquid private market, if other lenders follow suit.
“[RMBS] is a significant part of our strategy, and I think it’s a good first step in adding some diversified funding sources," said Brad Kotush, Home Capital’s chief financial officer, in an interview. “We’re happy to be part of that movement, but having more industry participants involved to create a deeper liquid market can only be a good thing."
The share of Canadian mortgages that are uninsured has grown rapidly to 59 per cent from 43 per cent in 2015, as policy changes such as mortgage stress tests made it tougher to qualify for insurance. Yet, only a tiny fraction of those loans are securitized for sale to private investors, some of whom remain wary of them because of the role risky mortgage-backed securities played in the last global financial crisis. A prolonged period of low interest rates has also made it hard for lenders to make a reasonable margin on securitized loans.
Home Capital is offering an annual interest rate of 3.01 per cent on a pool of what it calls “near-prime” mortgages, which are loans to home buyers who typically have solid credit or income, but can’t meet all the lending standards of large banks. Those loans carry average interest rates closer to 5 per cent owing to the greater risk of default, ensuring Home Capital collects a healthy margin.
The $425-million tranche of higher-quality loans is expected to be rated AAA by DBRS Ltd. and Aaa by Moody’s Investors Service Inc. It is being sold in a private placement to pension funds, insurance companies and large institutional asset managers in the United States and Canada. Home Capital itself will take up two lower-rated tranches totalling a further $75-million.
The offering “may be the first step in developing a functional non-prime RMBS market,” said Brenna Phelan, an analyst at Raymond James Ltd., in a research note. “From a higher level, this deal represents another example of funding for lenders in Canada becoming more innovative.”
A syndicate of banks led by Bank of America Merrill Lynch, and co-managed by BMO Nesbitt Burns Inc. and RBC Dominion Securities Inc., sold the securities to investors.
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James Bradshaw