Speaking Notes for Evan Siddall, President and Chief Executive Officer, Canada Mortgage and Housing Corporation
2018 National Conference for Canada’s Credit Unions
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Good afternoon; it’s a pleasure to be here. A special thank you to Martha Durdin for extending the invitation when we met in Ottawa back in January.
My objective today is two-fold. First, to let you know that CMHC values your business and respects the role you play in Canada’s housing finance system. And second, because you are an important part of the financial landscape in Canada, I want to reflect on how the strength of your businesses is crucial to Canada’s economic stability. We have requested information about your uninsured mortgage lending because we stand behind your institutions, and we need to know what risks that entails.
Before I get to that, however, I’d like to talk about similarities in our respective business models, our long history of working together and some opportunities for the future.
Like most credit unions do, CMHC makes its services available at the grass-roots level, in communities across the country, including rural communities where our private sector competitors are often absent. This is part of our mandate as a Crown corporation: to serve Canadians in all parts of the country, and to support all forms of housing. Working with credit unions, we have helped make homeownership possible for many thousands of Canadian families.
Our focus, like yours, is not on maximizing profits, but on helping people. In our case, we help Canadians meet their housing needs – Canadians are our clients. That’s not to say that we don’t keep an eye on the bottom line. Of course we do – we operate our mortgage loan insurance and securitization businesses on a commercial basis, without funding from the government and at no cost to taxpayers. We are obliged to generate returns in our insurance business to ensure that we don’t undermine our private sector counterparts. Over the past 10 years, we have contributed $16.5 billion to improving the Government of Canada’s financial position.
And even our mortgage loan insurance programs can support broader public policy objectives. For example, we offer easier qualification criteria for mortgage loan insurance on projects that will increase the supply of affordable rental housing, or for refinancing to help the owner of an existing affordable housing project undertake renovations and retrofits. We also have a special product to refund a portion of mortgage loan insurance premiums for Canadians who buy or build energy-efficient homes.
Like your companies, therefore, CMHC is very much a double-bottom-line enterprise.
National Housing Strategy – Building on past successes
CMHC and credit unions have achieved some great successes together. Let me give you a couple of examples.
In 2013, the federal government announced changes to our lending programs to allow non-profit and co-operative housing providers to prepay closed CMHC mortgages, enabling them to refinance at lower interest rates and to use the savings to repair and renovate their projects. Credit unions like Alterna were core contributors to this initiative, working closely with stakeholder groups and CMHC to extend refinancing opportunities to this vital sector.
Going back even further, in 1996 CMHC entered into an agreement with the Aboriginal-owned All Nations Trust Company to make direct loans as an agent of CMHC for rental projects in First Nation communities in British Columbia. In 2001, we transferred the administration of these loans to All Nations Trust. This effort in support of Indigenous capacity development is still going strong today.
We are looking forward to even bigger and better partnerships with credit unions through the historic National Housing Strategy, which was launched by the Prime Minister and our Minister, the Honourable Jean-Yves Duclos, last November. CMHC has been entrusted to lead this 10-year, $40 billion plan to improve access to affordable housing, especially for our most vulnerable populations. We need credit unions to help supply some of the private sector funds we are counting on to achieve our targets.
The $16-billion National Housing Co-Investment Fund, for example, will be used to create the next generation of housing, with a view to making communities more accessible and inclusive, and improving life outcomes for low-income and vulnerable people. Through a combination of loans and grants, the Fund will enable other levels of government and the private and not-for-profit sectors to build new affordable housing, preserve the existing affordable housing supply, and develop solutions to persistent challenges across the housing continuum. It represents CMHC’s primary contribution to new housing supply, the strongest antidote to the persistent demand pressures that are driving prices higher and preventing Canadians in our largest cities from being able to buy or rent affordable housing.
The Rental Construction Financing Initiative, which provides low-cost loans to support the construction of new rental housing that is affordable to middle-class Canadians, has proven to be immensely popular. Budget 2018 announced an additional $1.25 billion for this initiative, increasing the total available for lending to $3.75 billion over three years. This program gives CMHC authority to finance new rental projects during the earliest stage of development, when funding from private sector lenders is hard to come by.
And the Affordable Rental Housing Innovation Fund, with funding of $208 million over five years, is being used to test innovative financing and partnership approaches to lower the costs and risks of financing for affordable rental housing projects.
The National Housing Strategy aims to be game-changing in scope and impact: our goals include removing 530,000 households from housing need and cutting chronic homelessness in half over the next decade. But our ability to meet these targets will depend on maintaining strong and stable housing markets across the country. That’s why the other key component of our mandate – promoting the stability of Canada’s financial system – is so important. Not only does it help protect the economy in general, it will also safeguard these social investments. Given the obvious linkages between mortgages, banking and financial stability, we need to avoid “blind-side hits” that could weaken the system.
I’d like to turn to our concerns in this area for the next few minutes.
In a recent speech on financial stability, Senior Deputy Governor of the Bank of Canada Carolyn Wilkins noted: “The focus in Canada has understandably been on macroprudential policies related to household finance to improve the quality of debt and limit its growth.”1 CMHC has been at the centre of the policy changes and supportive of them.
As you know, successive rounds of policy actions over the past decade have progressively tightened the rules for mortgage lending, with the goal of promoting sustainable economic growth and diminishing risk in the system. The tightening was also part of an intentional effort to right-size the Government’s exposure to housing through CMHC, which had increased significantly during and after the financial crisis. Policy modifications have included tightening the eligibility criteria for mortgage loan insurance, increased down payment requirements and credit scores, maximum amortization periods and more exacting debt service ratios. In October 2016, the stress test for insured mortgages was extended to the key five-year fixed rate market and was applied to all insured mortgages, including low ratio loans.
Along with changes to OSFI capital requirements, these measures have put continued downward pressure on insured mortgage volumes, significantly changing the composition of mortgages in Canada as more business has flowed to the uninsured lending space. As a result, risk in the overall system is shifting.
As I’ve said in the past, and as Senior Deputy Governor Wilkins alluded, the gradual easing of government-sponsored borrowing was deliberate. These are intended consequences, to be clear, but consequences nonetheless. And while the latest revisions to the B-20 Guidelines include a more stringent stress test, the new requirements apply only to federally regulated financial institutions, or FRFIs. Having said that, some provinces – such as Quebec – are requiring credit unions to follow the B-20 level guidelines.
The new stress-test requirement has only been in place for four months, and we are only just now entering peak season for house sales. While media reports have suggested that credit unions and other institutions may be benefiting from some migration of business away from FRFIs, we have no hard data yet to support these claims. At CMHC, we believe in evidence-based decision making, and that means we rely on facts, not conjecture. And housing markets are given to anecdotes; we all have our stories to tell. Nonetheless, we need to be attentive to empirical changes in the mortgage market, and to better understand potential risks. Whether we are talking about a hockey game or our financial system, a blind-side hit, even from a “small player,” can be devastating. And just as the NHL is enforcing new rules to prevent blind-side hits, we need to do the same for housing.
Let me be clear: I am not suggesting that credit unions are putting Canada’s financial stability at risk. A recent study we commissioned by Deloitte concluded that credit unions have lower arrears rates than bank lenders, at 0.13 per cent compared to the rate currently reported by the Canadian Bankers Association of 0.24 per cent.2 Taken alone, this is of course a salutary observation.
Financial risk and institutional size
But this does not mean that significant risk factors are not at play that could expose CMHC to losses and negatively impact Canada’s housing financing system. The fact is: we don’t yet have sufficient or clear data to know either way, but we are taking action to remove the blindfold. Smaller lenders bring different risks.
For example, concentration risk is higher in smaller institutions. A study released earlier this month by the credit rating agency DBRS Limited noted that, while Canadian credit unions have relatively low-risk profiles, “… they are not immune to a downturn in their provincial economies and housing markets.”3 The report cites Saskatchewan as an example, where the major challenges experienced in that provincial economy pushed the ratio of Gross Impaired Loans for all lending by the credit union system to 87 basis points last year, well above the Big Banks. The DBRS report concludes that: “Exposure to economies dependent on cyclical industries and potential concentration risk makes it important for credit unions to maintain a low-risk profile.”4
The Deloitte study may also mask the complete picture. Our own securitization data tell us that, on average, credit unions have more mortgages going into arrears; however, due to proactive default management, the 90-day arrears and foreclosure rates are lower than the overall issuer average. So credit unions may in fact be originating weaker loans. Furthermore, it’s not clear whether, under more challenging economic conditions, these loans could be saved the same way they have been historically.
We have also seen a trend in recent years of some credit unions seeking loan growth and geographic expansion through the use of brokers or mortgage specialists, by purchasing loans from other lenders, or by providing collateral mortgages and leveraging CMHC’s securitization programs. Rapid loan growth raises questions about credit unions’ ability to properly assess and manage the risks of the loans they are putting on their books. Also, for securitized loans, the issuer is responsible for covering any difference between the cash flow receipts from underlying mortgages and payments due to investors.
Because your operations are not subject to many of the stringent new mortgage funding and capital requirements put in place by the Department of Finance and OSFI, risk management practices undoubtedly will vary from place to place. The small average size of credit unions drives a need for strong internal expertise in risk management, underwriting and default management. While the large players have guidance in line with OSFI’s standards, mid-tier and small credit unions tend to have less structured risk management practices.
Is this a problem? Not that we know of at this time. Could it be a problem for CMHC down the road? That’s a question we need to answer. As I’ve said, we simply don’t know what we don’t know. We are going to need your assistance and collaboration to fill some important gaps. Sunshine is called the best disinfectant. And if you’re confident in your risk management, you will welcome this, since it serves you well competitively. If there are some lapses in a few credit unions’ underwriting, let’s not allow the sins of the few be visited on the many.
Indeed, I believe credit unions are important and valuable actors in our financial system. Being closer to your clients results in a bespoke risk management given your more intimate familiarity with your clients. This is a service banks cannot easily offer to entrepreneurs, for example, who add to economically invaluable capital formation, innovation and job creation.
That said, a report on credit union trends in Canada released last fall by the law firm Fasken underscored some of the risks I have cited and raised others.5 The small size of credit unions can strain their ability to make the needed investments in technology that are transforming the financial sector. The Fasken report also cited risks associated with potential data security breaches, which can undermine consumer confidence in an otherwise solid brand. I don’t know a single CEO of a financial institution for whom cyber security is not a top concern.
The report’s authors concluded that “Credit unions are facing intense pressures. Consumer expectations and regulatory requirements are increasing, and significant resources are required to remain competitive …. While different credit unions are pursuing different strategies, one common element seems to be that adapting to the changing environment is a must. The one certainty is that the status quo is not an option.” This bears repeating: the status quo is not an option.
I am not aware of the failure of any credit union in Canada. But we know that past performance is not a reliable predictor of future results. Growth in the sector, and the continued consolidation of credit unions through mergers and acquisitions, can bring additional risks to CMHC that need to be properly assessed and managed.
Approved issuer framework
This is an important matter for us at CMHC. We offer a “timely payment guarantee” to issuers of mortgage-backed securities in Canada. CMHC therefore faces liquidity exposure to any “Approved Issuer” participant in our programs. We have a responsibility to taxpayers to manage these risks.
Uninsured mortgages are not subject to the same stringent rules as insured mortgages and the Bank of Canada has been very vocal about the growing risks in this segment of the market, including higher loan-to-income ratios and a higher number of 30-plus-year amortizations. We are particularly concerned about the possibility that non-FRFIs will take on increasing levels of riskier mortgage activity abandoned by FRFIs. Our timely payment guarantee exposes CMHC to the failure of any participant in our securitization programs. Moreover, as I’ve stated, we have a responsibility to isolate sound, solvent institutions from the contagion that can erupt when a lender fails.
This is why we are asking credit unions – along with all other participants in our securitization programs – to provide information on their entire mortgage portfolio – not just the portion insured by CMHC. As a systemically important financial institution, we need to understand the full extent of the risks we are exposed to through our securitization guarantees. The data we have requested will allow us to better understand developments and risks in the uninsured space, including trends and the migration of risks between program participants.
We recognize that this may mean additional work for some credit unions, mortgage finance companies and other non-federally regulated financial institutions. To minimize duplication of efforts, we have aligned this information request with existing reporting requirements. And as we said when we issued this advice, CMHC is prepared to work with issuers and their regulators to obtain the requested data in the most efficient manner possible.
From small to large: The domino effect
Moving beyond CMHC’s risk to the financial system in general, what could the consequences be if a credit union or other non-FRFI were to fail? Recent experience in the U.S. tells us that the failure of even a small lender can result in rapid loss of customer and investor confidence. Who remembers New Century Financial? It was founded in 1996 and within 10 years became the second largest subprime lender in the U.S., with $60 billion in mortgages issued in 2006. Its shaky originate-to-distribute business model unraveled very quickly in 2007. According to its Bankruptcy Examiner: “The demise of New Century was an early contributor to the subprime market meltdown.”6
You may also be familiar with the story of Northern Rock, a small bank in the U.K. that borrowed substantially during the early 2000s to fund mortgages. The company ran into trouble when the liquidity crisis gripped the world financial system and it was unable to repay the amounts it had borrowed. Word that Northern Rock had approached the U.K. government for support led to a bank run, as people rushed to withdraw their savings. Ultimately, the bank failed and was taken into public ownership to avoid insolvency.
People worry a lot about “larger” institutions, as they should. However, crises can be triggered by smaller institutions too, rather than only those judged to be “systemically important.” The “domino effect” can be powerful so we need to look past FRFIs.
Here in Canada, people were justifiably concerned last year that Home Capital’s circumstances threatened to destabilize our own financial system. Conventional stabilizers like deposit insurance proved ineffective as, almost overnight, Home Capital’s CDIC-insured, high-interest savings account deposits dropped 42 per cent. Investors smelled blood in the water and targeted Equitable Group, Canadian Western Bank and others. It was a tense time for all of us.
As the situation developed, the financial sector agencies collaborated together to evaluate risks and options for responding to a range of possible events. In this case, the private sector appropriately found a resolution.
So we are resilient to failures or potential failures of small players. We can deal with risks of one or two, but what happens if a few becomes several or many, and we don’t see it coming?
Financial instruments, including mortgage-backed securities, were primary risk-transmission vehicles during the global financial crisis.7 I’ve said before that you can’t pick up a house in Toronto and sell it in Halifax, but from a risk management perspective, mortgage pooling can have such an effect. At CMHC, we need to ensure that our programs do not propagate contagion. We need to make sure that all teams play by similar rules and that the temptation to take short cuts doesn’t compromise the integrity of the system. Otherwise, our ability to contain failures will be constrained. That’s not something Canadians – whom we all serve – would or should tolerate.
Kristin Forbes of the Massachusetts Institute of Technology, one of the foremost experts on financial contagion, asserts that sound, long-term economic and financial policy is the most reliable method of overcoming contagion. She draws an interesting comparison: “… just as lifestyle changes can reduce the risks of many diseases in the future, policymakers concerned about contagion in the future can adopt structural reforms to reduce (although not completely remove) contagion risks in the long term.”8
Credit unions have a strong preference for funding mortgages – insured and uninsured – through deposits.9 Nonetheless, their use of CMHC’s securitization programs has increased significantly over the past five years. Credit unions currently account for about 8 per cent of outstanding National Housing Act Mortgage-Backed Securities, compared to only 3 per cent in 2013. Over the same period, their proportion of outstanding Canada Mortgage Bonds has also doubled, from 6 per cent in 2013 to 12 per cent today. This makes credit unions, as a group, the fastest growing segment within our mortgage funding programs.
The information we are requesting is primarily to understand CMHC’s corporate risks and it is also important to Canada’s broader financial security. The information we gather will improve our understanding of housing market risks and inform future program decisions.
In closing, let me return to an analogy I used earlier. Whether we are talking about hockey or our financial system, a blind-side hit can be devastating. For an athlete, it can be career-ending. I don’t want to be the CEO of a company that has to absorb that injury. And for a financial system, it can be catastrophic, with the potential to wreak havoc globally.
This is why we are paying attention. So for all of you who run community lending institutions and hope for a fair game free of cheap shots, I know you will support our work.
1 Carolyn A. Wilkins 2018. “Financial Stability: Taking Care of Unfinished Business,” speech to a Rotman School of Management conference “Are We Ready For the Next Financial Crisis?,” Toronto, 22 March 2018.
2 Deloitte, 2017. Impact of Credit Unions and Mortgage Finance Companies on the Canadian Mortgage Market, Deloitte LLP, June 2017.
3 Roger Lister, Cheryl Saldanha, Henry Ye and Sohail Ahmer, DBRS Limited, 2018. “Canadian Credit Unions: Relatively Low-Risk Profile in 2018,” DBRS Limited, 3 April 2018.
5 Koker Christensen, Craig Bellefontaine and Tom Peters, 2017. “Canada: Current Trends In The Credit Union Sector,” Fasken, 4 September 2017.
7 Ben S. Bernanke, 2010. The Squam Lake Report: Fixing the Financial System, speech toThe Squam Lake Conference, New York, New York, 16 June 2010.
8 Kristin Forbes, 2012. “The Big “C”: Identifying Contagion,” National Bureau of Economic Research (NBER) Working Paper Series, Working Paper 18465, October 2012.
9 Approximately 80 per cent of mortgages issued by credit unions are funded through deposit, compared to 60 to 65 per cent deposit funding by other financial institutions.