On Monday June 20, 2011, MLI author Dr. Jane Londerville was asked to be a witness at the third meeting of the Standing Committee on Finance for Bill C-3, an act to implement certain provisions of the 2011 budget. A large section of the Bill is on private mortgage insurance and Dr. Londerville was asked to be a witness because of her recent analysis for the Macdonald-Laurier Institute on the mortgage insurance system in Canada, Mortgage Insurance in Canada: Basically sound but room for improvement.
Dr. Jane Londerville (Interim Chair and Associate Professor, College of Management and Economics, University of Guelph, As an Individual):
I have been a professor of real estate at the University of Guelph since 1993, teaching and doing research in the area of mortgage finance–among other interests. Prior to that, I did PhD studies in urban land economics at UBC, worked as a real estate consultant for six years for Ernst and Young, and completed an MBA at Harvard.
This past fall, I wrote an analysis of the mortgage insurance system in Canada for the Macdonald-Laurier Institute. Some of my comments today will be taken from that report.
I appreciate the opportunity to speak to this today. I will also be concentrating on part 7, which is where my expertise lies.
Canada can be justifiably proud of our mortgage finance system. Careful underwriting and legislation have allowed us to weather the global financial crisis better than almost any other country. The percentage of mortgages three months or more in arrears was less than 0.5% in February of this year. Since 1990 it has never been more than 0.7%. Even when–in quotation marks–“healthy”, the U.S. arrears rate was much higher than this.
So while the system is strong, there is always room for improvement. This legislation is a good start to recognizing the importance of opening the mortgage insurance market in Canada to competition from the private companies to give consumers greater choice and to allow for increased insurance product innovation.
Clause 42 allows the minister to tighten underwriting criteria, a critical safeguard of Canada’s system that prevented the types of careless lending in the U.S. from happening here. The minister can tighten underwriting requirements as deemed necessary, such as the reduction in the maximum amortization period for insured mortgages to 30 years, which was done this year. Mortgage insurance companies must follow these guidelines to retain their 90% backing, which enforces their adherence to this.
Despite the positive aspects of this proposed legislation, I have a couple of remaining concerns. As Finn mentioned, the CMHC, as a crown corporation, has its mortgage insurance policies implicitly 100% guaranteed by the federal government under the Basel accord. CMHC-insured mortgages, then, require no capital reserves by financial institutions. Clauses 22 and 24 in this act retain the corresponding maximum protection for private companies at only 90%. At the moment, the lender decides who will insure a mortgage loan: CMHC or a private insurer.
As a consequence, banks whose loans are insured through a private firm must set aside some capital reserves against the possibility of default by the insurer, which is not a requirement if the loan is insured by CMHC. Thus, rates of return are higher on CMHC-backed mortgages.
When profit margins are thin and banks are nervous about capital reserves, as in the financial crisis that began in 2008, this makes a major difference. The evidence of this is in the growth of CMHC’s mortgage insurance premium income during 2008 and the drop in Genworth’s.
Because of the difference in levels of guarantee, each financial institution’s treasury or risk officer determines how much of the institution’s mortgage insurance business can be sent to private investors, limiting the amount because of the capital reserve requirements. The implication of this for consumers is reduced choice. This is not a competitive marketplace with consumers freely choosing which company will insure their loan, even though they are the ones who pay the large upfront fee for this insurance.
CMHC’s stated plan for 2010 was to have $520 billion in insurance outstanding, which represents approximately 70% of the market. Genworth has been competing in this market since 1995 and holds most of the remaining 30%. To me, one party with such a dominant share of the market implies inadequate competition. There are now two relatively new competitors in the market to battle for the private company share of insurance. To make this a truly competitive market, changes to the 90% guarantee are necessary, either by reducing CMHC’s guarantee or by raising the one for the private sector.
The segment of CMHC that provides mortgage insurance and handles mortgage bonds and mortgage-backed securities is really acting as a large financial institution and does it very well. However, it does not at the moment fall under the oversight of the Office of the Superintendent of Financial Institutions. Private mortgage insurers are required to do extensive quarterly reporting to OSFI to ensure they are following regulations.
These data are publicly available.
Given exposure of taxpayers to 100% of CMHC’s mortgage insurance losses, it would seem prudent for OSFI to also regulate CMHC.
To conclude, I welcome the introduction of this legislation. However, I believe that through levelling the playing field for public and private mortgage insurers by giving the same guarantee and regulating through the same office, consumers would benefit. There would be more private insurers competing for their business, ensuring competitive fees and greater incentives for product innovation.