Bankers sound alarm on loans

John Greenwood, Financial Post · Thursday, Dec. 9, 2010

Some of Canada’s top bank executives are growing increasingly uncomfortable with the level of debt Canadians are taking on through long-amortization mortgages.

“I think all of us are looking at [what to do],” said Ed Clark, chief executive of Toronto-Dominion Bank, adding the current situation “is not a good thing.”Speaking in an interview, Mr. Clark said TD has already acted to slow lending but it’s now up to the federal government to take steps such as reducing maximum amortization periods on home loans to 25 years from 35 years or lowering loan-to-value ratios.“These are exactly the things that government should be doing and there’s been a lot of discussion,” he said. Bank of Montreal CEO Bill Downe said his organization is also doing what it can to rein in customer borrowing, but fixing the problem without hurting the economy is “the challenge for Canada.”

“I think [tighter mortgage rules] is consistent with maintaining healthy consumer debt levels,” he said, suggesting the changes could be included in the next federal budget.

Meanwhile, the Bank of Canada is again raising the alarm about the perilous state of household finances. In the December issue of the Financial System Review released Thursday, it singled out elevated consumer debt as a “key risk” for the Canadian economy.

Fuelled by rock-bottom interest rates and a rising real estate market, Canadians have been borrowing at a rate much faster than their income has grown — especially over the last two years — raising concern that they are becoming vulnerable to economic shocks such as rising unemployment and stagnant wages.

For the first time, the value of mortgages outstanding — the biggest chunk of consumer debt — recently topped $1-trillion, according to Bank of Canada statistics.

A spokesman for Canadian Bankers Association declined to comment on whether it is lobbying the government for tougher regulations.

“Banks have contributed with their own economic research to the ongoing public discussion about household borrowing and debt levels in Canada, and there is broad agreement that this is a matter that merits close attention,” said Terry Campbell, vice-president of policy at the Canadian Bankers Association.

The banks first approached Ottawa asking for tighter lending rules at the start of the year. In February, Finance Minister Jim Flaherty gave them what they wanted, unveiling a list of changes to mortgage rules, including a requirement forcing all homebuyers to meet the standards for a five-year, fixed-rate loan even if they chose a variable mortgage with a shorter term. There were also rules lowering the maximum amount consumers could borrow against their homes to 90% from 95%.

The trouble was consumers barely noticed as the spending spree went on largely unabated. According Moody’s Investors Service Inc., household debt levels relative to income are following a similar trajectory as in the United States during the credit bubble.

Bank officials argue it’s unfair to compare the two countries because mortgage lending standards have always been much tougher in this country and there was never a major subprime mortgage sector.

Nevertheless, requirements did get loosened in the bubble years when the government allowed the amortization period on mortgages rise to 40 years.

“Originally, we said moving from 25 years to 40 years was a mistake,” Mr. Clark said. “We didn’t think it was a good idea. [When the crisis hit] the government moved back from 40 to 35 and I think from a public policy view, over the long run, it would better to get back to 25.”

He said it’s the responsibility of the government and not the banks to tighten the rules because it’s the government that regulates the market.

“If CMHC policy is 35-year [amortization], not 25 years it’s very hard for the industry to say, OK, let’s move to 25 years,” Mr. Clark said.

For his part, Mr. Downe said, he’s not trying to tell the Department of Finance what to do.

“I’m not prescriptive but I think those kinds of ideas [such as shortening amortizations] resonate,” he said in an interview earlier this week.

Moving to shorter amortizations would likely have a significant impact on the market. Statistics Canada finds 42% of all new mortgages are for amortization periods of more than 25 years.

The Housing Death Spiral Means A Mammoth One In Five Borrowers Will Default

Michael David White, Housing Story Oct. 4, 2010, 8:08 AM

A Mammoth One in Five Borrowers Will Default

A leading mortgage analyst predicts over 11 million homeowners will default and lose their home if the government fails to take more radical intervention.

Amherst Securities Group LP, one of the most respected names in mortgage research, has trumpeted an ambitious call-to-government arms in its October mortgage report.

“The death spiral of lower home prices, more borrowers underwater, higher transition rates (to default), more distressed sales and lower home prices must be arrested.”

The authors dismiss recent talk of mortgage performance improvement as statistical sleight-of-hand magically conjured by modifications.

“This ‘improvement’ (in mortgage performance) simply reflects large scale modification activity having served to artificially lower the delinquency rate” (Please see the chart above of mortgage balances delinquent and re-performing. All charts in this post are from “Amherst Mortgage Insight” dated October 1, 2010.).

The report offers an astounding forecast of the fate of severe negative-equity properties. Nineteen percent of properties with a loan-to-value (LTV) of 120% or greater are defaulting every year. A death-defying 75% of mortgages on 120% LTV properties will eventually go bad (19% + 19% + 19%, …).

The current crop of mortgages is already “impaired” at the one-of-five level. Nine of 100 are seriously delinquent. Six of 100 are “dirty current” (made current by modification). Five of 100 are seriously underwater (LTV greater than 120%) (Please see the chart above categorizing the forecast of 11 million defaults.).

The authors, who describe current conditions as leading to “an impossible number” of defaults and one that is “politically unfeasible”, unveil a major arms race of measures to counteract the default tide.

The solutions include mandatory principal reductions, looser underwriting of new mortgage loans, leveraged capital pools for investors, and penalties for defaulting homeowners. Amherst reports that a family who defaults can live rent-free for 20 months on average. They propose that missed mortgage payments, including property taxes and insurance, be counted as W2 income.

They make note of recent new signs of distress including two record-low readings of existing home sales in the last two reports. Another block is that underwriting standards have grown much stricter at Fannie and Freddie. Only 2% of Freddie purchases are now bad-credit borrowers where they represented about 20% of borrowers in 2006. FHA purchase mortgages, however, which have by definition much more lenient lending guidelines, have exploded upwards from roughly 10% of their lending in 2006 to more than 50% today.

The buyer pool is also compromised by the fact that 17% of borrowers now have a seriously compromised credit history. After mortgage default a typical wait-time to qualify again is anywhere from 3 to 7 years. One of the more desperate measures suggested by the authors seeks a new mortgage for those who are now behind or in danger of failing. “This (default) can be fixed by re-qualifying borrowers who are in a home they can’t afford into one they can afford.”

Risk is so high in today’s real estate market that private money has largely left the mortgage category. The retreat is most easily seen in the jumbo mortgage market. Total jumbo mortgage origination has fallen from a high of $650 billion in 2003 to $92 billion in 2009 (see the chart above). Government loans account for 90% of current originations.

“If government policy does not change, over 11.5 million borrowers are in danger of losing their homes (1 borrower out of every 5),”‘ the report said, which estimates the total of homes with a first mortgage at 55 million. “Politically, this cannot happen.”