The secret plan to break up the CMHC
Analysis: New CMHC head leads focus on financial industry, risk management
Board members will be required to have more knowledge of balance sheets, financial acumen
Canada Mortgage & Housing Corp., which insures $563 billion of mortgages, named former Bank of New York Mellon Corp. CEO Robert Kelly chairman last month amid government pressure to upgrade management. He joins a board that includes a partner in a plumbing company and the former solicitor of a town in rural Nova Scotia.
CMHC has been told by the government to behave more like a commercial financial institution. In response, CMHC is ensuring its directors know as much about balance sheets as home improvement.
CMHC is screening its board of directors for an enhanced set of skill requirements, including experience in the financial industry and risk management, according to a Nov. 5 memo obtained under freedom-of-information laws. They include a requirement for “financial acumen and literacy,” says the memo, which was labelled “confidential” and addressed to Human Resources Minister Diane Finley, to whom the agency reports.
The federal government has been strengthening oversight of CMHC, which insures most mortgages in the country and which would be the nation’s sixth-largest bank by assets.
The changes suggest those overseeing CMHC “don’t like what they see,” said George Athanassakos, a finance professor at Western University’s Ivey Business School in London, Ont. The economic risks of a housing-market decline justify taking “aggressive measures” at CMHC, he said.
“Consumers are leveraged,” Athanassakos said in an interview. “Combined with an over-priced housing market, it doesn’t bode well for the economy and the financial sector.”
The agency, established in 1946 to address a housing shortage at the end of the Second World War, began insuring mortgages in 1954, partly to encourage private lenders to play a bigger role in mortgage underwriting. By law, mortgages in Canada with down payments of less than 20 per cent must be insured. CMHC’s insurance is fully backed by the federal government, and the government has capped the amount of insurance it can offer at $600 billion.
CMHC also issues Canada Mortgage Bonds and uses the funds to buy mortgage-backed securities from financial institutions. The Bank of America Merrill Lynch 1-5 Year Canada Housing Trust Index, comprising 11 mortgage bonds with a par value of $88 billion Cdn, has returned 0.52 per cent this year through Tuesday, compared with losses of 1.1 per cent for Canadian government debt and gains of 0.92 per cent for an index of the nation’s corporate bonds.
Kelly’s experience in housing finance and capital markets “will be of great benefit to CMHC,” Finley said in the statement that announced the appointment. The former Wachovia Corp. chief financial officer and Toronto-Dominion Bank executive “will ensure the continued strong governance of Canada’s national housing agency.”
Finance Minister Jim Flaherty has taken steps to rein in CMHC in an attempt to shield taxpayers from a potential downturn in the nation’s housing market. In last year’s fiscal plan, he directed the country’s financial regulator, superintendent of financial institutions Julie Dickson, to review CMHC’s books at least once a year. The government also placed the most senior bureaucrats in the Finance and Human Resources departments on CMHC’s board.
Karen Kinsley said recently she will step down as CMHC’s chief executive officer when her term ends June 17. Kinsley, a fellow of the Institute of Chartered Accounts of Ontario, had been with the agency for more than 25 years. CMHC said June 3 it is seeking a “dynamic and visionary” CEO with risk-management experience and knowledge of financial markets.
The majority of directors, other than the finance and human resources officials, should have “senior” experience in the financial industry or risk management under the changes laid out in the memo.
Directors are also being screened for experience or expertise judging corporate and executive performance. Board members were already required to demonstrate knowledge of CMHC’s commercial operations and have experience in real estate and social housing.
“While the previous board skills profile always called for experience and knowledge in the areas set out in the current board skills profile, there is now an increased emphasis, in particular, on experience in the financial industry,” spokesman Charles Sauriol said in an email.
“CMHC continually updates its governance and risk management practices,” Sauriol said. “As the organization evolves, so too will the skills required of the board.”
Finley representative Alyson Queen said the memo represented “a continuation of the enhanced governance” promised in Flaherty’s budget. A representative of Flaherty, Kathleen Perchaluk, deferred to CMHC when asked to comment on the memo.
Brock Kruger of OSFI said by phone the regulator’s review of CMHC covers the agency’s commercial operations, not its board governance.
There are 12 positions on CMHC’s board. Current members include Anne MacDonald, the solicitor who helped manage real estate for Pictou, N.S. MacDonald’s biography on CMHC’s website says she has “extensive knowledge of provincial and municipal law” and primarily practises “real estate, wills, probate, municipal law and family law.”
The board also includes Rennie Pieterman, a partner in Practical Plumbing Co. Ltd. of London, Ont. Her CMHC biography says she served eight years on the board of directors of the London Home Builders’ Association, including as president in 2003, and has been a member of the association’s Renovators’ Council since 1994.
MacDonald didn’t respond to two voice-mail messages seeking comment. Pieterman declined to comment when contacted by telephone, referring questions to Kelly, who wasn’t available for an interview according to Sauriol.
Board members should have a wide range of skills and bring “qualifications and experience related to CMHC’s overall operations and mandate,” Sauriol said in an emailed statement. All of the current directors “possess a range of experience in housing-related areas, such as housing finance, aboriginal and seniors’ housing, residential and commercial construction, real estate and public policy.
Household debt has risen to a record 165 per cent of disposable income as Canada relied on a housing boom and consumer spending to lead the world’s 11th-largest economy out of the 2008 global financial crisis. Canadian house prices have increased 16 per cent in the past five years, according to the Teranet-National Bank Composite House Price Index. By comparison, U.S. prices measured by the S&P/Case-Shiller index of property values fell 11 per cent over the same period.
Flaherty said in his March budget that he would limit use of CMHC’s portfolio insurance, which covers home loans with down payments greater than 20 per cent.
The government said the change was intended to restore “taxpayer-backed portfolio insurance to its original purpose of allowing access to funding for mortgage assets.” Since the 2008 financial crisis, Canadian lenders have used government-backed insured mortgages to shore up capital in line with international standards.
Flaherty said in May that CMHC has grown into a “major financial institution” and needs to operate like one. Canada’s banking regulator OSFI “has been over there doing some stress testing, and we’re going to continue monitoring CMHC very closely,” he said.
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The secret plan to break up the CMHC
Larry Smith delivers his warning about the state of Canada’s housing market in the kind of gruff, no-nonsense tone you might expect from a guy who’s seen it all before and said everything he thought he could in years past, back when people might have listened.
Canada Mortgage and Housing Corp., the country’s national housing agency, is finally on the path to being operated like a significant financial player which it has morphed into during the past decade.
A new chairman of the board, a soon-to-be unveiled chief executive and a new reporting structure that will overhaul its operations are the tangible indications of the fundamental changes playing out behind closed doors at the Crown corporation that have been set in motion by the federal government.
“It looks like we’re going to see the same problems [that I warned about] reappear and nothing’s been done to alleviate them,” said Mr. Smith, officially retired but still a professor emeritus at the University of Toronto’s economics department, specializing in real estate.
“I’m pretty disappointed,” is all he has to say of the fact that much of what he predicted more than 30 years ago about Canada’s taxpayer subsidized and precariously overvalued housing market has come true.
Back then he was a vocal critic of government policies that paved the way for a major expansion of the role of the public sector in the housing market — mostly through the Canada Mortgage and Housing Corp. (CMHC), the government-owned mortgage insurer.
In 1979, Mr. Smith was appointed deputy chairman of a federal task force set up to “study the potential for privatization” of the activities of the CMHC. The task force report, which was never released publicly according to Mr. Smith, came down squarely on the side of the free marketers.
The CMHC should “cease writing mortgage loan insurance, except in extreme circumstances when the private market cannot supply this service in remote areas,” the 130-page document advised. The report also raised troubling questions about the lack of transparency within the Crown corporation, making it difficult to properly analyze the financial implications of the insurance program.
It makes for an interesting read three decades later as the country gets set to contend with a potentially severe correction in house prices.
The Organization for Economic Co-operation and Development warned earlier this month that Canada is among the world’s over valued real estate markets, leaving it vulnerable to rising interest rates or unemployment. The comments come in the wake of similar red flags raised by policy makers such as former Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty.
Much of the discussion about what’s wrong with the housing market focuses on the CMHC, which now counts as one of the country’s largest financial companies, owing to its substantial portfolio of mortgage guarantees covering nearly $600-billion of outstanding home loans, roughly 30% of Canada’s GDP.
Critics say the CMHC is under-charging for its policies, which has opened the door for housing speculators and enabled banks to push the risk of default on hundreds of billions of dollars of mortgages onto the shoulders of government — bottom line, the CMHC is the primary cause of the bubbly market.
The CMHC has always denied this. It has taken the position that while the taxpayer is the one ultimately holding the bag, the risk of losses spilling over onto the government is actually miniscule because of the responsible manner in which business is conducted and the fact that the insurance premiums have been piling up year after year, contributing to a capital surplus of nearly $14-billion — more than enough to cover potential losses from any potential housing correction.
For the last few decades, the CMHC has managed to churn out regular profits, and of course it’s hard to argue with success. But the thing about housing is that it’s a market like any other, except that the cycles tend to last longer than most. And often the busts are painful.
You only need to go back to the late 1970s to see what a difficult housing bust looks like. By then, the period of prosperity characterizing previous decades had given way to rising unemployment and economic uncertainty. With job losses mounting, housing prices began to wilt and the pain quickly spread to the CMHC.
Launched in 1946 to help provide housing for soldiers returning from the Second World War, the CMHC administered a range of subsidy programs focused around mortgage assistance and social housing. Mortgage insurance soon entered the picture and, gradually morphing into a core function by the 1970s. That set the stage for what came next.
The CMHC’s annual report for 1979 paints a disturbing picture:
“The year saw a further increase in claims on the Mortgage Insurance Fund. Claims had started to increase in 1977, accelerated in 1978 and then more than doubled in 1979. All these claims resulted in the Fund acquiring real estate that could not be readily sold because of long-standing constraints on the Corporation’s real estate practices….”
“In each Annual Report from 1976 onwards, reference has been made to the diminishing viability of the corporation under present financial and legislative arrangements. Developments in 1979 reinforce the need either to change these arrangements or the explicit recognition of CMHC’s financial problems.”
Mortgage insurance claims arising from borrower default soared that year, leaving the CHMC with more repossessed homes than the cumulative total since it got in to the business in 1954. But the recession had only just got going. Interest rates, already stratospheric by today’s standards, started to move up, sparking more defaults and a further slowing of economic growth.
Soon the CMHC found itself administering tens of thousands of foreclosed homes across the country, an enormous portfolio that quickly became an administrative burden and a source of unforeseen problems. For instance, the organization was required by its mortgage insurance contracts to compensate banks following a default, but due to the explosion in defaults and tumbling housing prices that simply wasn’t possible. At one point, the CMHC had possession of more than 40,000 foreclosed homes. As a result, the mortgage fund became so depleted that the government had to step in on at least one occasion with emergency funding.
Then, as now, Canada’s housing market was partly supported by the arrival of new immigrants but as the recession ground on, immigration fell off, exacerbating the mess.
Indeed, the troubles were so severe that the funding deficit rose to nearly $800-million, leaving the CMHC technically insolvent.
To be fair, the CMHC was a different beast in those days. When mortgage insurance wasn’t enough, prospective home buyers could qualify for something called the Assisted Home Ownership Program (AHOP), where the CMHC covered part of the mortgage interest payments. And mortgage insurance itself was cheaper, partly because the fees charged to borrowers didn’t even cover the cost of administration.
Subsidies like the AHOP have long since gone by the wayside and mortgage insurance is considerably more expensive.
“In the late 1970s and early 80s, the mortgage loan insurance business was managed mostly on a cash basis and without a comprehensive capital management framework,” said Teresa Amoroso, a spokesperson for the CMHC. “As such it is difficult to compare today’s mortgage insurance business, which operates on a commercial basis, with the pre-commercialized activities of the 1970′s and 80′s.”
As well, she points out, the CMHC is today under the oversight of the Office of the Superintendent of Financial Institutions, the federal banking and insurance regulator. “CMHC currently has more than twice the minimum level of capital reserves as set out under OSFI guidelines.”
Still, the old annual reports are recommended reading for anyone trying to understand how things can go wrong when the unexpected happens.
But mortgage insurance is only part of game …
The cost of buying a home: It’s not just the mortgage, silly!
Associated costs include down payment, closing costs, moving costs and new appliances.
With rents rising in the city of Toronto, some first-time buyers are eager to enter the housing market.
Adam Frank and his girlfriend MaryAnne, both 29, knew they wouldn’t become homeowners overnight.
The two were realistic and grounded in their approach. They had conversations. They researched. They crunched numbers.
The couple knew buying a house in Toronto could put them over the edge. When the time came to stop renting and finally buy their first home, the couple opted for a condo.
“We knew what the costs were going to be and we were comfortable with them,” says Frank. “We were renting for three years. We just both knew it was time to invest.
“It’s still under construction, but we took occupancy January 16. Rumour has it we’re going to close in June or July.”
With rents rising in the city of Toronto, some first-time buyers are eager to enter the housing market. According to the Toronto Real Estate Board, the average monthly rent for a one-bedroom condo is $1,597, up 4 per cent from last year. Garden-level apartments, a euphemism, on Craigslist, for basement apartments, list upward of $1,300 per month. At 1.7 per cent, vacancy rates remain low.
Investing in a condo is appealing as these properties generally come with a lower price tag. Royal LePage reports the price of the average condo in Toronto was $356,865.
Buyers can’t shop on the listing price alone.
Mark Salerno of Canadian Mortgage Housing Corporation (CMHC) says the first step towards homeownership is understanding the complexities of a mortgage.
“There’s an expectation that a homeownership is a natural conclusion, so that you eventually move into something that you own,” he says. “You really have to understand what that entails in terms of what your budget will need to look like.
“Closing costs alone can be extremely significant.”
Consider this example: someone buys a condo for $240,000. This buyer would need a minimum of 5 per cent, or $12,000 as a down payment. If they don’t want to incur mortgage default insurance, they’ll need a 20-per-cent down-payment of $48,000. Tack on another 4 per cent, or $9,600, for closing costs, plus another $2,000 or so for moving costs and some new appliances. That’s more than $59,600 for the privilege of having a mortgage.
Buyers should go to the bank or lender and determine how much of a mortgage they’re qualified for based on their financial circumstances.
“The lender is going to look at your assets and your liabilities,” says Salerno. “What they’re going to be able to do is essentially screen you for what you can afford.”
This will help narrow the scope and help you shop for a home you can afford.
“That’s going to be really vital for when you go and talk to your realtor,” he says. “You may have a whole set of criteria, but, ultimately, what you can afford is going to be the biggest factor that dictates what listings you should really be looking at.
It’s not all about the mortgage.
“There’s a whole range of considerations you need to think about even before you start to look at homes,” he says. The neighbourhood, the size of the home, the family’s goals and lifestyle and school planning all come into play.
“If you haven’t made these fundamental determinations, then you’ll be overwhelmed with the choice,” Salerno says.
Jennifer Tomic from Toronto knows home ownership is for her. The thirty-seven-year-old is eager stop renting and get into the market. She’s been approved for a mortgage, but doesn’t want a condo. Because of high costs, she’s holding out.
“Trying to find an affordable house on your own is really hard. I’ve tried to recruit my friends to go in on a mortgage with me,” Tomic says. “It’s a business transaction, but trying to find someone willing to invest is hard.
“I just don’t feel like I have enough money.”
Know your options
It’s important to choose a mortgage payment schedule that works for you. There are four standard payment options: monthly, semi-monthly, biweekly, weekly. But you can save thousands of dollars in interest costs by making accelerated payments.
Monthly: 12 standard payments per year.
Semi-monthly: 24 payments per year. The total amount paid at the end of the year is the same as the monthly option; it’s a monthly payment split in half.
Biweekly or every two weeks: The total amount paid at the end of the year is also the same, but the calculation changes; it’s a monthly payment time 12, divided by 26
Accelerated biweekly: You will make 26 payments per year, but you’ll make the equivalent to one extra payment per year. To calculate what extra you’ll pay, divide your monthly payment by two. For example, $1,000 ÷ 2 = $500. This will save you money in interest costs and help you pay off your mortgage faster.
Weekly: 52 payments per year; the monthly payment times 12, divided by 52
Accelerated weekly: You will make 52 payments a year, but you’ll make the equivalent to one extra payment per year. To calculate what extra you’ll pay, divide your monthly payment by four. For example, $1,000 ÷ 4 = $250. This will save you money in interest costs and help you pay off your mortgage faster.