Canada's banks are looking for cheaper ways to fund new mortgages as buyers continue to defy expectations for home sales.
With Ottawa reining in the growth of Canada Mortgage and Housing Corp.'s ability to insure new pools of mortgages, banks are increasingly turning to its private-sector competitors, including Canada Guaranty, the country's third-largest mortgage insurer.
The shift is part of a dramatic turnaround in fortunes for that company, which was called AIG United Guaranty until 2010 and watched its market share shrivel just a few years ago. For the broader economy, the growth of Canada Guaranty's portfolio highlights a bet that both it and its new owners – including the Ontario Teachers' Pension Plan – are making on the resiliency of the housing market even as its fate polarizes industry watchers.
Ottawa decided this year to make CMHC stay within a $600-billion cap on the amount of insurance it can have in force, as Canadians rack up large mortgage debts and push consumer debt levels to new highs.
Andrew Charles, the chief executive officer of Canada Guaranty, says that move has changed the market dynamics. "Those market implications have served to reinforce to lenders that diversifying the amount of suppliers you have is critical," he said.
CMHC is now rationing the amount of portfolio insurance it sells to banks. Mortgage insurance pays a bank when a borrower defaults. Portfolio insurance covers an entire portfolio of uninsured mortgages, and makes it easier for banks to securitize them or have them packaged into bonds which reduce their funding costs and allow them to lend more. Insurance also reduces capital requirements.
Canaccord Genuity analyst Mario Mendonca estimates that $88-billion or 13 per cent of the big six banks' $700-billion in mortgages have been covered with portfolio insurance and then securitized or used in a covered bond program.
"Over the last few months we've received numerous requests from various lending institutions in terms of portfolio insurance," Mr. Charles said. And the company can use that to lure in more regular mortgage insurance business, because portfolio insurance is something it only offers "valued customers."
Both Mr. Charles and Teachers' head of private equity Jane Rowe say they are comfortable with the state of the housing market.
"We think that maybe [house prices will]go down a bit, but we think the housing market today is pretty stable," Ms. Rowe said in an interview. Recent positive news on employment is a good sign, because jobs are a key driver of stability in the mortgage market, she said.
"I think we're growing the company at the right time," Ms. Rowe said.
Teachers' and its partner Stephen Smith, the chairman of First National Financial, grabbed the opportunity to buy the company when American International Group was in need of funds.
The Canadian mortgage insurer's business had floundered as the near demise of its former parent company, AIG, damaged its reputation. And the financial crisis had caused banks to flee to the safety of CMHC, a Crown corporation whose insurance is fully guaranteed by the government (Ottawa guarantees 90 per cent of the insurance from the two private-sector players).
Now, CMHC is facing growth constraints and Ottawa is expected to increase the amount of insurance in force that Canada Guaranty and its other competitor Genworth MI Canada Inc. can have this year.
Moreover, financial markets have become more stable, making the banks less concerned about the additional government guarantee for CMHC. And Canada's banking regulator made it clear to banks last month that they are welcome to buy mortgage insurance from Canada Guaranty and Genworth as long as they're comfortable any insurer they use is sound.
Bank of Nova Scotia signed a deal last week to begin using insurance from Canada Guaranty in addition to the other players, which it was already buying from. Canada Guaranty has long been selling insurance to Canadian Imperial Bank of Commerce and last year signed on Bank of Montreal as a customer. Insiders say it expects to confirm a deal with at least one more big bank by the end of this year.
"We've been aggressively hiring, largely increasing our underwriting capacity to handle increased high ratio volumes," Mr. Charles said.
Canada Guaranty's business strategy focuses on scooping up profitable business, not market share, Mr. Charles said. But it's not without risk.
The firm was a money-loser before the Teachers' consortium bought it. "Given Canadian consumer debt loads, rising interest rates could result in a correction in house prices – especially if accompanied by a slowing economy," rating agency DBRS wrote in its most recent report on Canada Guaranty. "Such a development could cause the company to return to a loss-making position, requiring additional capital injections from shareholders."
Before the financial crisis, CMHC had about 65 per cent of the market, Genworth 30 per cent, and AIG 5 per cent. But by 2009, CMHC was writing about 80 per cent of new business with Genworth taking nearly all of the remainder, according to rating agency DBRS.
Paul Holden, an analyst at CIBC who covers Genworth, said that Canada Guaranty's market share is still below 5 per cent. He estimates that it will be several more years before Canada Guaranty corners 10 per cent of the market.