A slow-moving economic crisis is the biggest financial risk to Canada Mortgage and Housing Corp.’s mortgage insurance business, according to documents obtained by the Financial Post via an access-to-information request.
The August 2019 report by an actuary from KPMG on the mortgage-insurance activities of CMHC said the Crown corporation’s expected future financial condition was deemed “satisfactory,” as of the end of 2018, partly because assets would still outweigh liabilities in several bad scenarios.
One example was for a “5/30” recession where the unemployment rate increases by five percentage points and an index of home resale prices drops by 30 per cent.
However, “a slowly developing economic scenario, like 5/30, represents the greatest threat to the financial condition” to CMHC’s business, the report suggests, since it could drive its mortgage insurer capital adequacy ratio below an industry-wide target set by the Office of the Superintendent of Financial Institutions.
The regulator’s supervisory target for a mortgage insurer’s available capital is 150 per cent of its minimum capital required; CMHC’s ratio as of Sept. 30 was 197 per cent.
The heavily redacted report outlines the annual dynamic capital adequacy (DCAT) testing of CMHC’s mortgage insurance business. The testing “is performed in order to gain an independent view on capital adequacy for our mortgage insurance business,” and the actuary was making a “general statement” regarding a potential economic scenario, a spokesperson for the Crown corporation said in an email.
The spokesperson said CMHC stress tests its overall capital levels annually “to determine our ability to withstand severe but plausible scenarios,” and that its stress-test scenarios are not predictions or forecasts.
CMHC is Canada’s largest mortgage insurer, so the state of its finances is important to the financial system and broader economy. Despite a shift towards uninsured mortgages in recent years, the agency in its most recent quarterly results said it provided mortgage insurance for more than 69,000 homes for the three months ended Sept. 30, with total insurance-in-force of $433 billion.
In recent years, stress test scenarios have included “financial stress,” persistently low oil prices, a global trade war, earthquakes, cyberattacks and volcanic eruptions.
“Our corporate-wide stress testing and the DCAT results both show we are well capitalized to handle very severe situations,” the spokesperson said. “CMHC develops internal action plans for extreme scenarios, including a slowly developing economic scenario.”
The spokesperson also said CMHC has used the so-called 5/30 scenario “for a number of years” as part of its corporate-wide stress testing.
For example, CMHC in Oct. 2017 said it tested its mortgage loan insurance business against several scenarios, including a “U.S.-style housing correction” in which there would be a five percentage point increase in the unemployment rate and a 30-per-cent drop in house prices.
The housing-crash scenario would have caused $217 million in losses for CMHC from 2017 to 2022, the biggest loss of any of the five disclosed scenarios, according to the agency’s results.
“In each case, our testing confirms that our capital holdings are sufficient to weather each of these extreme scenarios,” a press release at the time said.
But similar to the prior year’s DCAT report, the 2019 version states, “the most significant threat to the financial condition of (mortgage insurance) is a slowly developing adverse economic scenario.”
Mortgage insurance is meant to protect banks and other lenders against losses that could be caused by a borrower not paying the lender back. Default insurance is required when borrowers make a down payment of less than 20 per cent of the value of a home, and the cost of the premium is passed on to the homebuyer.
Although concerns of a recession in Canada have eased — and unemployment levels are near historic lows — anxiety about the economy has not entirely eased. Canadian economic growth slowed toward the end of 2019, and consumer insolvencies rose 9.5 per cent in 2019 compared to 2018, according to the Office of the Superintendent of Bankruptcy Canada.
The Canadian Association of Insolvency and Restructuring Professionals (CAIRP) is projecting consumer insolvency filings will continue to grow this year, with mortgage renewals a possible tipping point for some borrowers. Canada’s household debt stands at a record $2.3 trillion and around $1.5 trillion of that is tied to mortgages, CAIRP board member André Bolduc said.
“Housing eats up a lot of your monthly budget,” he said. “If employment became an issue, that would definitely increase insolvency rates.”
The KPMG report recommended that continuing to develop better early warning signs of a deep recession could help improve quarter-end decisions about dividends the Crown corporation pays to the federal government.
As for future improvements to the financial condition testing, the report mentions including the impact of the First-Time Home Buyer Incentive ushered in under the Liberal government, since it is a shared-equity mortgage that “is not reflected in this DCAT report.”
The CMHC spokesperson said the corporation’s mortgage-insurance business has not faced a “severe” economic scenario in recent history.
“However, during the global financial crisis of 2008, Canada, while not unscathed, fared better than most thanks in part to CMHC acting as an economic shock absorber,” the spokesperson added. “Our Insured Mortgage Purchase Program helped provide Canadian banks with operating liquidity, thus helping to stabilize housing markets and the housing finance system.”
Financial Post
