The federal government’s recent policy announcement signals a clear intent to be more flexible in its housing finance policies and programs. Below we discuss key areas of change where CMHC, with support from the Department of Finance, could improve the funding efficiency of the Canada Mortgage Bond (CMB) program and expand mortgage funding volume without increasing the program’s issuance size.
Hedging in the CMB program
A major challenge for participants in the CMB program is how they hedge their origination pipelines. CMBs are issued on a regular basis, with issuers accumulating mortgages, creating mortgage-backed securities (MBS), and hedging this pipeline by shorting another security. This is typically done by selling a bond and managing the resulting “short” position through the repo market. However, this exposes issuers to spread risk, as the spread between the CMB and the Canada bond can change. A more effective hedge would be to short the CMB itself.
There are rumblings that CMHC is discouraging program participants from shorting the CMB, likely due to concerns this could lead to spread widening. However, given that the government purchases a significant amount of each CMB issue, allowing shorting could help to create a more active market for these bonds. If CMHC has concerns about this practice, it should consider creating a “when-issued” (WI) market for CMBs. WI trading allows new securities to trade between the announcement and issuance dates, promoting price discovery. This may reduce market uncertainty and potentially lower the borrowing costs associated with the CMB program. For this to work, CMHC would need to establish a regular offering cycle, but this adjustment could improve hedging efficiency and reduce overall program costs.
Expanding the scope of eligible reinvestment assets
Another area for improvement is expanding the scope of eligible replacement assets within the CMB program. As the underlying mortgage portfolio ages, principal is repaid and must be reinvested until the CMB matures. Reinvestment assets are supposed to be relatively risk free, but ideally should also have a yield similar to the original mortgages. When the program was originally designed, asset-backed commercial paper (ABCP) backed by mortgages, was a key reinvestment asset. However, with recent rule changes prohibiting insured mortgages in this funding channel, the amount of eligible ABCP has significantly declined.
Additionally, the phasing out of the bankers’ acceptance program as part of the transition from CDOR (Canadian Dollar Offered Rate) to CORRA (Canadian Overnight Repo Rate Average) – two key interest rate benchmarks – is shrinking the money market, leaving a $90 billion gap. Expanding the eligibility of reinvestment assets to include ABCP backed by prime mortgages or other mortgage assets aligned with the government’s object of expanding housing finance could address several issues. This would enable more mortgage financing, improve program economics, and allow program participants to be more aggressive in their asset funding. It would also provide greater funding flexibility for CMB aggregators, making program economics the key cost driver rather than transfer pricing from their bank treasuries. It could also stimulate growth in the ABCP market, as a mortgage-based ABCP program would not be limited to selling exclusively to the CMB program.
By addressing these issues, CMHC and the Department of Finance could significantly enhance the efficiency and scope of the CMB program, benefiting both participants and the broader housing market.
Independent Opinion
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