The recent federal budget stated “[t]he government intends to undertake market consultations on the proposal to consolidate the Canada Mortgage Bonds within the government’s regular borrowing program, including on an implementation plan that would ensure stable access to mortgage financing. The government will return in the fall economic and fiscal update on this matter.”
Background
When the Canada Mortgage Bonds (CMB) program was launched in 2001, the government did not want the debt from the program to be on Canada Mortgage and Housing Corporation’s (CMHC) balance sheet. The program was initially structured as debt issued by Canada Housing Trust (CHT), an off-balance sheet special purpose entity.
The Trust buys National Housing Act (NHA) mortgage-backed securities (MBS) from lenders and issues bonds to investors. To manage the cash flow and duration mismatch between the MBS and the CMBs, the Trust arranges cash flow swaps with the highly-rated swap counterparties.
The bonds are supported by cash flow from the mortgages, which are insured against borrower default. The bonds themselves have a timely payment guarantee from CMHC, which is ultimately backstopped by the federal government. Despite these layers of protection for investors, the bonds trade at a spread over Government of Canada bonds.
CMHC did try to get the bond market to trade CMB’s as Canada bonds, but it was unsuccessful as the bonds are not directly issued by the federal government. Consequently, they were issued at a spread to Government of Canada bonds. In launching the CMB program, CMHC made sure the bonds traded from the government bond desks instead of the structured finance desks to limit the spread differential. At best, the 5-year CMB has traded as tight as 6 basis points to Government of Canada bonds; it is currently trading with a roughly 30 basis point spread (100 basis points equals 1 percent).
Around $40 billion of CMB’s are issued every year with the typical term being 5-years, which aligns with the most common term for single-family mortgages. As at March 15, 2023, there were $244.75 billion of bonds outstanding.
Crown agency debt (predominantly foreign debt issues by Export Development Canada), CMBs, and federal debt require Parliamentary Authority under the Borrowing Authority Act. Beginning in 2008, the Government undertook to borrow on the behalf of several Crown Corporations. This generates a loan receivable for the Government which is recorded as an asset. The debt issued to fund these loans appears as part of market debt.
Our expectation is that a similar approach will be followed for CMBs. The government would not want to buy mortgages and manage the cash flow and prepayment risks of the portfolio; CHT can do that. CMHC would plan the regular funding cycle in consultation with Finance and the Bank of Canada; the Government would fund CMHC/CHT, which would transfer the funds to program participants in exchange for NHA MBS.
Below we have given our views on possible changes to the program.
Funding process. Since this is a funding program that supports a broad range of lenders, having an auction process for funds would be counter to the CMB program’s objectives of lowering funding costs for consumers. An auction favors large banks which will likely behave in an oligopolistic fashion. Smaller lender access is a key design element of the program. Allowing mortgage investment entities as well as credit unions and small banks equal access with the major banks is important to supporting the housing finance system and ultimately consumers.
Since there would be no investment dealer syndicates there would be a potential cost savings of approximately $60 million. The biggest potential savings is the spread between Canada bonds and CMBs. Potentially, the government would want to charge some spread over Canada bonds to create a funding source for social housing. Assuming $40 billion annual issuance, every 5 basis points captured by the government would generate $20 million in funding that could be used for social housing. There could be up to $120 million in potential annual funding generated for social housing at a 30 basis point spread. However, this assumes that the current spread is the right spread. The challenge will be to support affordable housing without hurting housing affordability.
Funding cycle. Since the CMB program is large, it will need to be re-engineered to align more closely with government funding auctions to avoid large cash demands on federal funding operations. Having the CMB program align within the federal bond auction cycle is the most likely step.
CMB product. Currently, the CMB is constrained by investor demand for a 10-year product, which limits potential funding for multi-family projects. Having the product based on the 10-year Canada bond would remove this constraint. Also, to the extent that the government is looking to provide longer term funding for affordable housing, having access to funding across the federal yield curve would be a major benefit.
The CMB program issues floating rate notes (FRNs), which are not part of the federal debt program. FRNs are not a large part of the funding raised by the CMB and have a small investor base. It would not be a significant problem for the program if this product was cancelled. However, given there are large regular treasury bill auctions, there are opportunities to restructure the floating rate funding operations of the CMB program to be more efficient.
Bank and credit union liquidity management. CMBs are considered high quality liquid assets (HQLA). These institutions can also create HQLA through NHA MBS, which are eligible collateral under the Bank of Canada’s standing liquidity facility. As a result, no changes should be required for liquidity management.
Other spread product. Removing CMBs should have some benefit to the provinces as there will be less high-quality spread product in the market. This could see some spread tightening for provincial debt. There could also be more demand for MBS products as investors substitute NHA MBS for CMBs.
Aggregator/swap desk asset management. A key part of the asset manager and swap desk role is to manage the cash flow timing mismatches between the assets (NHA MBS and eligible reinvestment assets) and liabilities of the Trust (CMB). Swaps pass the economics of the MBS plus reinvestment risk to the lenders, and the bond payments back to the Trust. CMBs could be used as eligible reinvestment assets (positive carry versus Canada bonds). To the extent these desks were using CMBs, they will likely have to switch to NHA MBS.
Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.
