Over the years, various efforts have been made to expand the Canadian mortgage securitization market. While some lenders have created Residential Mortgage-Backed Securities (RMBS) programs, large-scale active issuance has yet to materialize. Since these are largely one-off transactions, investors have not allocated resources to actively trade this product.
There have been suggestions that changes to the prepayment penalty provisions in the Interest Act would encourage longer-term mortgages. Longer terms help reduce rollover risk, a key concern for rating agencies when assessing securitization structure. Borrowers have had access to longer-term mortgages in the insured market but have shown little interest in them. Although there are calls for a US-style Mortgage-Backed Securities (MBS) market in Canada, we lack both the required infrastructure and consumer demand to support it.
Even in the National Housing Act (NHA) MBS space, trading activity has declined. Banks issue NHA MBS but primarily hold them for liquidity management rather than active trading. With limited market activity, dealers have downsized their MBS trading staff. The NHA MBS market was more active 25 years ago, when banks like TD would conduct large market transactions and US-based funds actively traded the product.
While the CMB program has been a success, it has also limited investor participation in the NHA MBS program. Investors prefer the liquidity and regular semi-annual interest payments offered by the CMB program. Without an active MBS market, this asset class is not a core focus for money managers.
Developing a sustainable mortgage securitization market: CMHC’s role
The National Housing Act outlines key roles for CMHC, including:
- to promote the efficient functioning and competitiveness of the housing finance market.
- to promote and contribute to the stability of the financial system, including the housing market.
Currently, CMHC is focused on multifamily housing. This has worked well for the CMB program, as multifamily borrowers typically prefer 10-year funding, while residential borrowers tend to favour 5-year terms. However, with the yield curve no longer inverted, multifamily borrowers are now seeking 5-year products, which will likely crowd out funding for single family mortgages.
A potential solution would be for CMHC to create a new residential MBS program. Instead of buying NHA MBS and issuing bonds, CMHC could issue securities based on the cash flow of the MBS. The simplest structure would involve creating a large pool of NHA MBS and issuing a new passthrough security. This program could issue securities during months when the CMB is not actively issuing products. This would allow CMHC to create large, liquid MBS issues, and regular issuance would make the program attractive to investors.
These passthrough securities could be structured separately for residential and multifamily markets. Over time, CMHC could look to develop more complicated structures, such as a Real Estate Mortgage Investment Conduit (REMIC) that issues a range of securities to investors.
REMICs are treated as flowthrough structures in the US, similar to how Mortgage Investment Corporations (MICs) are treated in Canada. The key difference is that in the US, REMICs are considered partnerships. This tax treatment has allowed US agencies Fannie Mae and Freddie Mac to create specific securities for credit risk transfer.
CMHC should explore how to replicate this approach or consider using credit-linked notes to transfer risk. This would help mitigate the government’s increasing exposure to credit risk through the program. CMHC would need approval to increase the authorization for its timely payment guarantee. However, since there has never been a claim against this guarantee since the NHA MBS program was created, this risk of increasing this exposure is limited.
The are several benefits to this approach:
- It would generate investor interest in NHA MBS, helping to expand the securitization market by creating an active government market.
- It would provide an additional funding tool for lenders.
- Wrapping these structures with a risk transfer mechanism would limit CMHC’s credit risk exposure and help establish a risk transfer market for mortgages.
While this may seem like a step backward, it is essential to lay the foundation for a government-backed MBS program before we can expect the market to develop securitization solutions for riskier mortgage products.
Independent Opinion
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