The Impact of Bulk Mortgage Insurance on the Canadian Mortgage Market

Aug 7, 2012

Why is it that a client, who has saved a 20% (or more) down payment for the purchase of a home, seems to have fewer borrowing options than the first time buyer with only 5% down? Why are many of the best lender special offers only applicable to high ratio mortgages? The answer lies in mortgage default insurance (or the lack of it) and in who pays the insurance premium. When concerns arose earlier this year over CMHC quickly approaching its legislated limit of total mortgage default insurance in force ($600 billion), portfolio or “bulk” insurance found itself clearly in the cross-hairs (for reasons discussed below) and CMHC acted to restrict bulk insurance volumes for lenders in order to preserve their ability to write standard (also known as 
“flow”) mortgage default insurance policies. So, what is bulk insurance, why and where is it used, why has it grown so quickly over the past couple of years and what impact does it have on the Canadian mortgage market now and going forward?

Back to the client who has a 20% down payment. The good news for her is that she is not required to purchase mortgage default insurance. Her 20% equity cushion (provided that she meets other basic underwriting criteria) is deemed to be sufficient and she saves herself the cost of the premium (which is almost always financed as part of the mortgage). Her mortgage is a conventional, uninsured mortgage. As with any mortgage, her lender has a range of options in terms of how to fund it: they can hold it on their own balance sheet or sell her loan to another investor or to the capital markets through a securitization structure or an MBS (mortgage backed security). But her lender’s options are more limited than they would be if her mortgage was insured. So, her lender may choose to insure the mortgage anyway and pay the insurance premium itself. 

Why would they consider this? Lenders purchase bulk insurance for three main reasons: first, insured mortgages are simply easier to sell to investors. If given the choice, an insured mortgage is, for any investor, a less risky investment than an uninsured mortgage is – and the yields are generally equal. Most securitization and MBS structures will only accept insured mortgages and most covered bond programs (another way of selling mortgages to the capital markets) also use only insured mortgages.

The second reason is to gain capital relief. Canadian financial institutions are required to maintain capital reserves to back-stop their loans. Insured mortgages (where credit losses are covered through the insurance), for obvious reasons, carry lower capital requirements than uninsured ones do. Lenders will of course crunch the numbers and compare the cost of bulk insurance premiums to the cost of allocating capital to uninsured mortgages but capital is often better deployed elsewhere, making bulk insurance premiums the cheaper alternative.

The third reason for insuring low loan-to-value mortgages is to reduce credit risk. For large institutions like Canadian banks, this reason is much less relevant as they have strong underwriting criteria and decades of experience in the performance of their loan portfolios. For smaller lenders, there is value to them in moving credit risk out of their portfolios and it also allows them to sell the assets more easily if they choose to do so.

When CMHC began to approach the $600 billion mortgage insurance limit, the rapid growth in bulk insurance was seen as one of the main reasons. This recent spike resulted from the growth in the use of covered bonds as a funding mechanism for banks (which usually require only insured mortgages). When CMHC moved to restrict bulk insurance volumes, the two private mortgage insurers in Canada, Genworth and Canada Guarantee, stood to benefit – as long as investors were comfortable with a slightly reduced government guarantee. CMHC’s liabilities are 100% guaranteed by the government of Canada – ie, Canadian taxpayers.

Private insurers enjoy only a 90% guarantee. During times of great economic uncertainty (like 2008 and 2009), investors preferred the full government guarantee and CMHC’s insurance volumes soared at the expense of the private insurers. Investor appetite for mortgages insured by one of the private insurers has returned and this is reflected in Genworth’s Q2 results which were released last week. In the second quarter of this year, of the $18.8 billion of new mortgage insurance issued by
Genworth, $13.1 billion was in the form of bulk insurance, representing nearly a 700% increase over the same period in 2011. They clearly benefitted from CMHC’s pull back and are now approaching their own limit of $250 billion in total insurance in force. This is expected to be increased to $300 billion for both Genworth and Canada Guarantee by the end of this year.

The mortgage market seems to rely more and more on bulk insurance as lenders increasingly choose strategies which move assets off their own balance sheets (by selling to investors or the capital markets which desire or require insured only mortgages) or position themselves to do so later if conditions warrant. When the concept of mortgage insurance was created, it was intended for high ratio purchases for borrowers who had not saved the usual 20% or 25% down payment. Conventional mortgages with significant borrower equity were seen as less risky.

Now, they require more capital to support them and they are seen as more difficult to sell. Private insurers have stepped in and filled the void created by CMHC’s pull back from bulk insurance. If we enter another period of severe economic turmoil, private mortgage insurance, with its 90% guarantee, may not be as easily saleable as it is now. What then? CMHC’s $600 billion limit could be increased but there are political reasons why this is unlikely. Otherwise, your client who has saved their 20% down payment may need to invest some of her savings elsewhere and get a high ratio mortgage instead. Their lender will be more than happy to lend them the insurance premium which they will need to pay.

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