Speaking Notes for
Evan Siddall, President and Chief Executive Officer Canada Mortgage and Housing Corporation
Panel Session at the Global Risk Institute Annual Conference
234 Bay Street
November 10, 2015
Check against delivery
It’s great to be here with Ben (Tal) to talk about some of the risks facing Canadian housing markets, including the potential risk of significant foreign ownership in key markets.
Last year I spoke about our unique role as a manager of tail risks.
Some of you may recall that I said that housing markets at that time, while overvalued, were not problematic. I also said it was my job to worry about ugly scenarios and the possibility we were wrong.
So far so good – but I’m still worried.
As I said last year, greater transparency from CMHC is one way to better manage risk. We don’t pretend to know it all.
We have now made four releases of the Housing Market Assessment (HMA), which pinpoints problematic conditions in Canadian housing markets.
The HMA analytical framework looks at four key factors: overheating, price acceleration, overvaluation and overbuilding. Results are presented at the national level and for 15 Census Metropolitan Areas.
The latest HMA update shows an increase in housing market vulnerabilities.
Canada is not one housing market but several local housing markets.
Overvaluation is now detected in 11 CMAs, an increase from eight in the August 2015 release.
Combined with other evidence of house price acceleration or overbuilding, the HMA framework points to strong overall evidence of problematic conditions in Toronto, Winnipeg, Saskatoon and Regina.
We have also consistently enhanced our disclosure of financial information. Last year, we went beyond one of the B-21 requirements when we began publishing an Insurance Business Supplement with our quarterly financial reports.
This year, we’ve taken it a step further and have begun publishing both a Securitization Supplement and a Covered Bond Supplement.
As Canada’s authority on housing, we are committed to leading through information and insight and supporting decision making and risk management practices through the provision of timely and relevant data.
We recognize there are significant data and information gaps, and we are working to identify and fill them.
We have concluded our “data gaps” assessments and are now focusing on four priorities. Some we can tackle on our own; in other cases, broad collaboration will be needed amongst government agencies, lenders and other stakeholders.
More information is needed on the total volume of all mortgages issued in a given time period, on new condominium sales, and on primary and secondary rental markets.
And fourth, we need to better understand the extent of foreign ownership in Canadian residential real estate, which is the subject of our panel discussion today.
A lack of accurate and reliable data makes it difficult to determine if or how foreign investment may be affecting the market. Most of the available information is anecdotal. And the problem is that many foreign investors may prefer to hide their ownership.
While both domestic and foreign investment activity can be speculative, foreign investment may be more mobile and subject to capital flight. This would increase volatility in domestic housing markets.
The presence of foreign investment can also contribute to housing market vulnerabilities such as overvaluation. In Vancouver and Toronto, for example, it is very possible that foreign buyers account for a substantial portion of the demand for pricier, luxury single-family homes.
This is a natural deduction based on recent studies. According to a survey of realtors conducted by Sotheby’s in 2013, international buyers accounted for 40 per cent of total luxury home sales in Vancouver and 25 per cent in Toronto.
More recently, Andy Yan, an urban planner in Vancouver, released a study indicating that nearly 70 per cent of luxury homes sold in West Vancouver neighbourhoods were to buyers from mainland China. Statistics from other realtor entities in Vancouver appear to corroborate findings that international buyers are a large part of the segment driving the demand for single-family luxury homes.
The challenge with such studies is that others often disagree with the methodology being used or are concerned about the sample size. Nevertheless, their findings can’t just be ignored. Using the idea of Mosaic theory, it is possible that by gleaning as many pieces of information as possible, we have a story here that makes sense.
Given that our HMA framework is based on past behaviour, the changing mix of real estate ownership could undermine the validity of our framework.
We have taken some initial steps to fill the data gaps related to investor activity and behaviour, including foreign investment.
We now ask property managers to provide information on the number of condominium apartment units owned by people whose primary residence is outside of Canada.
It’s clear that we need to capture more detailed information on foreign investment, to better inform the Canadian government and housing market participants. Options being considered include involving local realtors, developers and land registry offices to obtain annual residential sales to foreign buyers for condominium and freehold units.
High levels of household debt remain a key vulnerability to housing markets and financial stability.
The ratio of Canadian household debt to personal disposable income reached a high of 164.6 per cent in the second quarter of this year.
Although residential mortgage arrears rates remain low and credit scores are strong, household debt remains a vulnerability that would amplify an economic shock.
For example, in the event of a material increase in the unemployment rate, many households may need to access their wealth to make ends meet for a period of time.
However, with household equity being concentrated in a non-liquid asset such as housing, the impact of such a shock could be amplified by the need to sell, resulting in a sudden glut of homes for sale, putting downward pressure on prices and eroding household wealth. The obvious feedback loop is something we want to avoid.
We work very closely with our colleagues at the Department of Finance, the Bank of Canada and OSFI in exploring means to ensure we avoid contributing to household imbalances.
On the topic of increased transparency, we have had a robust internal debate on the merits of publishing our stress testing results. As you may know, this is not a common practice for Canadian financial institutions.
As a publicly owned insurer, we believe we should account for our work, and that we should welcome commentary and reasonable, productive criticism. And our investors – you – deserve an accounting. Publishing our stress test results is the next step in our transparency.
I have decided to share this information with you today.
Like other organizations, we have a formal, structured process to consider the potential impact of extreme events on our businesses.
Stress testing is an essential part of our risk management program, and we have made significant investments in enhancing our stress testing processes and capabilities as we strive to become a best in class risk manager.
The stress testing and risk identification/assessment processes are linked:
- We choose scenarios that help us understand the particular vulnerabilities that are identified through our risk management processes.
- Risk management is everyone’s business at CMHC – identifying and developing the scenarios involves our business lines, risk management sector and other key corporate groups.
- It is both a “bottom-up” and “top-down” process. Input and approval from senior management and the Board of Directors are important, but so is the input and engagement of employees in our first line of defence.
A failure of imagination is all that prevents us from coming to terms with the risk we carry. Honestly, we considered wild, very unlikely ideas. The case of a “zombie apocalypse” had traction, briefly ...
The scenario envisions a 30 per cent decline in house prices and a five per cent increase in unemployment – sound familiar – like maybe the 2008 US housing market crash?
This is the primary bedrock scenario that is used to set the capital levels for our mortgage loan insurance business.
Such an event would result in almost an eight-fold increase in insurance claim losses, from $1.7 billion to $13.2 billion over our five-year planning horizon.
Our cumulative net income would go from a $7.5 billion profit to a $2.8 billion loss, again over the five-year planning horizon.
These are very severe impacts, and I’m not at all predicting this outcome, but it is worth noting that our capital position is quite strong and our ending capital ratios would be well above our minimum capital target of 100 per cent MCT, equivalent to OSFI-mandated minimum levels for our private competitors.
There are two additional implications to underscore here:
- First, these losses are fully borne by us, with no losses taken by the banks and lenders that originated the loans.
- And second, since the government’s fiscal position has benefitted from our historic profits – $15 billion over the past decade – it would have to absorb our losses in a stressed scenario such as we have contemplated.
Insurers would not design a situation this way, if done from the start. Good insurance practice includes skin in the game by the insured to align behaviour and incentives and avoid moral hazard.
As I’ve said, we are exploring ways to share these risks (and profits and losses) more equitably in the financial system.
In addition to this bedrock scenario, we also modeled three additional cases developed via our internal scenario planning exercise, a first for us at CMHC.
With the help of an outside firm, we considered three scenarios that we chose based on their representation of emerging and potentially impactful risks:
- Global economic deflation persisting for our five-year planning horizon;
- Oil price shock involving sustained $35 per barrel oil prices for five years; and
- A magnitude 9.0 earthquake epi-centred in Vancouver that also resulted in the failure of a major lender.
Each case stresses our business differently. However, none of them depletes our capital below our 100 per cent minimum capital level, the point at which we would stop underwriting new business.
No surprise, the most challenging case – sustained global deflation – generates the greatest losses, especially when we assume we are the only game left in town. In that case, we lose $8.9 billion over five years, and are left with 147 per cent capital levels in our Insurance business, compared to our current level of 337 per cent.
The bottom line: it would take a very severe housing downturn and a big jump in unemployment rates, both persisting for a number of years, to start eroding our capital in a significant manner.
In addition to helping us to set our capital thresholds, stress testing also provides an opportunity to test our operational resiliency to respond to a crisis. Are our processes, systems and people capable of handling unexpected events and or emergencies?
We conducted a table-top exercise to assess our readiness to respond to a cyber attack targeting emili, our mortgage loan insurance underwriting system.
This was not an ordinary table-top exercise, since we challenged ourselves to create a scenario where not only does the operational site go down but also the back-up site, and not just for an hour or so. This required a lot of imagination.
Among the lessons learned from this exercise was that we need to better coordinate our business resumption communications processes to deal with instances where our current almost 100 per cent availability and reliability gets impacted; and we need to continue to invest in data governance and data security.
Inspired by this stress test and emili’s vulnerability as a single point of failure, we are also developing contingency plans for such a heretofore unimaginable event.
We do a really good job at risk management at CMHC, and we’re getting even better. Part of this involves a modest recognition of our own limited imagination and blind spots, our best efforts notwithstanding.
The truth, as Tim Geithner said in his book Stress Test, is that “financial crises can’t be reliably anticipated ... because human interactions are inherently unpredictable.”
Rather than absolving us of responsibility, this recognition motivates CMHC to be more open, to invite criticism and suggestions from clients, risk practitioners and commentators on how we can do a better job.
For this reason, while I am previewing these results with you, we are not confining our audience just to you. We will publish my remarks on our website later today.
Stress testing strengthens an organization’s risk culture in several ways.
It increases the involvement of everyone, from the Board through to the first line of defence, in the process: stress testing is no longer a “black box” exercise managed by Risk Management.
It also has a business impact, as the results have led to different business and strategic decisions or confirm that things are okay as is.
It promotes “outside the box” thinking and supports the development of resilient, innovative and flexible organizations.
As I said last year, as a Crown corporation with a mandate to help backstop the stability of the financial system, it is imperative that CMHC be a best-in-class risk manager.
We’ve made good progress in reducing taxpayer exposure to the housing market and establishing a consistent risk culture across the organization.
I’ve said we insure tail risk. As such, our lens must be more finely tuned. In order to serve as the shock absorber we are supposed to be, we must look beyond the obvious and foreseeable.
But as Geithner also famously said, “Plan beats no plan.” And at CMHC, rest assured we have a pretty good plan.