Mortgage market tiptoes toward subprime
As the big banks get choosier about who they'll lend money to in this hot housing market, people with questionable credit are benefiting from Canada's once-small but now booming subprime mortgage industry.
The Canadian Real Estate Association released figures Monday showing Canadian home sales rose 2.5 per cent in March, and the average Canadian home sold for $369,677 last month.
That was actually a slight decline from the level of a year ago, but it comes on the heels of almost uninterrupted strong gains over the previous two years.
Fuelling that boom is a growing pile of mortgage debt, an increasing amount of which isn’t coming from Canada’s major lenders. That’s largely because of recent developments at the Canada Mortgage and Housing Corporation.
The CMHC is the Crown corporation mandated to oversee Canada’s housing industry. The vast majority of Canadian mortgages show up on its books, because CMHC insures the mortgages approved by banks.
In 2010 and again in 2011, hoping to slow down a red-hot housing market, the Department of Finance tinkered with the rules surrounding who can qualify for CMHC-insured mortgages. Moves to shorten the maximum length of the mortgage and raise the minimum percentage a borrower must have as a down payment combined to make CMHC insurance harder to come by.
"The banks don’t want to take on anything that’s not insured by CMHC," Toronto mortgage broker Marcus Tzaferis of Morcan Direct says. "So that’s pushing borrowers farther and farther out of the mainstream to find financing."
Industry experts suggest the big banks are currently rejecting as much as 20 per cent of mortgage applications because they don’t qualify for CMHC insurance.
But alternative lenders like Home Capital Group, Equitable Group and Counsel Corp. have stepped in to fill the market niche of funding borrowers who don’t meet traditional lending requirements — known in industry parlance as "subprime" borrowers.
'There’s a perception that Canada avoided the subprime mortgage crisis because we’re conservative and we have a good system. But it’s not really the case.'—Benjamin Tal, CIBC economist
"There’s a perception that Canada avoided the subprime mortgage crisis because we’re conservative and we have a good system," CIBC economist Benjamin Tal says. "But it’s not really the case."
Exact figures of how big the market is are hard to come by. Canada’s total housing market was worth about $1.1 trillion at the end of 2011, the Bank of Canada estimated in a recent report.
Toronto-based investment firm M Partners says Canada’s alternative mortgage market could potentially be worth as much as $85 billion within that. That’s approaching 10 per cent of the market and it’s growing, fast.
Tzaferis says the section of his business that deals with subprime borrowers is up maybe 50 per cent in recent months. "It’s not a huge part of the business but there’s definitely been a spike in activity."
Growth rates like that are something policymakers like to keep an eye on.
"It’s pretty small for now," Tal says. "But if things keep growing the way they are, there’s absolutely the potential for it to become a problem."
They go by many names, but whether they’re known as subprime, alt-a or near prime, alternative mortgages play a legitimate role in any normal-functioning housing market.
Self-employed people, recent immigrants and those with poor or no credit history often have trouble securing financing from traditional lenders. But the recent tightening of CMHC rules is pushing more and more people into the fringes.
"A good 30 to 40 per cent of that business isn’t real subprime; it’s prime business that for whatever reason isn’t qualifying anymore," Tzaferis notes.
Despite running a business that takes in several millions of dollars a year worth of mortgage deals, Tzaferis says he himself would have a hard time getting a mortgage from a conventional lender in this market because of the way his business and his income is structured.
'The banks don’t want to take on anything that’s not insured by CMHC.'—Marcus Tzaferis, mortgage broker
Steve Loutskou is in a similar situation. Now 29, Loutskou first got into real estate in his early twenties. With a sizable down payment on his first property in 2006, lenders were eager to work with him. But as he expanded his real estate portfolio with more and more properties, his down payments got smaller, leverage got larger and conventional funding sources dried up.
"What I've been doing is just going to alternative," Loutskou says. "I pay the fees, I pay the higher rates, because I just don't want the headache."
Those fees can add up. The average posted five-year mortgage rate at one of Canada’s big banks is currently 5.1 per cent. That compares with a 5.9 per cent average rate within the portfolio at Home Capital Group, the leader in Canada’s subprime mortgage market with about 30 per cent of the market.
"We have a lot of alternative customers that the banks turn down … that may not have the credit history," Home Capital president Martin Reid says.
"It's a whole different market, anything non-prime," he says. "Real subprime are people with poor credit."
Reid suggests that the total size of what Home Capital calls the "non-prime" mortgage market is about 20 per cent of the overall market, or $200 billion.
The industry has ballooned to encapsulate people who wouldn't ordinarily have been on the fringes of the market.
"All of a sudden, instead of getting a three per cent fixed-rate mortgage, buyers are signing up for six," Tzaferis says. "If more and more people are getting thrown into subprime, how many are going to take that three per cent hit without asking questions?"
Proportionately, Canada’s subprime market is about the size today as the U.S. market was in roughly 2004 or so, Tal notes. After 20 years on the fringe of the housing market, by 2007, about a third of U.S. mortgages were subprime.
In retrospect, it’s easy to see that was a bubble about to burst, and Tal suggests part of the reason Canada was spared the same sort of speculative froth was because the U.S. market imploded so completely.
Some bad apples may spoil market
To be sure, few are suggesting a U.S.-style meltdown is anywhere near at hand. A major factor in the U.S. meltdown was rampant securitization of mortgages, where loans were divided into more and more tranches and sold to investors farther afield — watering down the underlying risk of the debt itself.
There's little evidence Canadian mortgages are anywhere near as spread out, nor is there any widespread indication that so-called "NINJA" loans — an acronym for people with No Income, No Job or Assets — that were prevalent before the U.S. bust have made any sort of foothold in Canada.
But as Tal notes, "this low interest rate environment is a good place for subprime activity to start mushrooming."
Subprime backers say alternative lenders merely provide an opportunity for capable buyers like Loutskou to buy in to a buoyant market.
"It’s not something that keeps me up at night, because if you look at the details of most of the deals, you’d be more than happy to hold them, and they’re very profitable," Tzaferis says.
Loutskou, too, has few concerns.
"If I'm paying an extra per cent on my mortgage, it doesn't really make a difference to me," he says. "Point being that I actually get a mortgage."
Indeed, it’s fair to say the systemic risk is also somewhat limited because subprime activity is largely happening outside the purview of the taxpayer-backed CMHC anyway. But that doesn’t mean there isn’t a downside.
Many worthwhile borrowers are taking advantage, but those rejected by conventional lenders might actually be bad apples in disguise. If those borrowers fall behind, the taxpayer might not be on the hook for any defaults, but the market as a whole may have to absorb forced selling at an inopportune time, which could lead to wider price declines.
"It’s certainly not something you’d want to see get any bigger," Tal says.