Submission to the Inquiry into Competition in the Banking and Non-Banking Sectors Appendix A: The Canadian Securitisation Market

In Canada, there are two closely related government-owned entities that participate in the domestic mortgage market – the Canada Mortgage and Housing Corporation (CMHC) and Canada Housing Trust (CHT). Their roles are to increase liquidity in the domestic residential mortgage market, promote home ownership, and improve housing affordability. There are no equivalent institutions in Australia; all of the main participants in the housing finance market and the related RMBS markets are privately owned, yet the size of the RMBS market is very similar to that in Canada.

In Canada, CMHC:

• provides an unconditional guarantee on all RMBS issued under the National Housing Act (termed NHA-MBS), guaranteeing the full and timely payment of principal and interest in the case of default;^[9]
• is the largest provider of lenders' mortgage insurance in Canada; and
• is a significant provider of social housing and housing research.

CHT was established in 2001 to further develop the RMBS market. Its main role is to issue CMHC guaranteed Canada Mortgage Bonds (CMBs) and use those funds to purchase NHA-MBS. Since the introduction of CHT, the share of outstanding mortgages in Canada that are funded by RMBS has doubled to 20 per cent, with NHA-MBS more than accounting for this growth. This share is similar to that in Australia, though Australia has achieved this growth without a government housing agency (Graph A1).

CMHC/CHT effectively provides subsidised funding to the smaller, fringe lenders. CMHC/CHT have a government imposed cap on the quantity of mortgages that they can fund. In normal conditions, they are usually able to fund all of the mortgages that are offered to them. This is because the larger lenders fund most of their loans directly, rather than through CMHC/CHT, and hence the cap is not a binding constraint.

The recent capital market turbulence has pushed up the cost of private capital market funding markedly, resulting in a significant increase in demand for CMHC/CHT finance from both large and small lenders. Because of its cap, CMHC/CHT was unable to fund all of the mortgages that were offered to them; in its December 2007 and March 2008 funding rounds, the agency funded a set value of mortgages offered by each lender, but only partially funded requests that were greater than this value. Large lenders were forced to raise most of their funds from higher-cost private sources, and set their mortgage rates accordingly. The smaller lenders, which are fully funded by CMHC/CHT, set their mortgage rates in line with the large lenders, thereby expanding their interest margins. The smaller lenders had little incentive to undercut the large lenders as they could not obtain additional funding from CMHC/CHT to accommodate any additional lending. Hence, even though CMB yields (Graph A2) have declined by about 90 basis points (in comparison to a 120 basis point fall in Canadian 5-year Treasury bond yields), households' 5-year fixed mortgage rates have fallen by only 20 basis points. The government subsidy was retained by the smaller financial institutions, rather than passed on to households.

As discussed in the main text, the increases in variable and fixed mortgage rates in Canada have been similar to those seen in Australia, suggesting that the Canadian housing agencies have not had a significant impact on mortgage rates during the recent capital market turbulence.

Footnote

The National Housing Act (NHA) is legislation that was introduced in 1944 to improve housing and living conditions for Canadians. [9]