From $4 Billion To ? Canadian Insurer Stops Disclosing Underwater Mortgages

One of Canada’s Big 3 mortgage insurers is no longer publicly sharing its underwater exposure. Canada Guaranty quietly dropped the value of mortgages with negative equity in its latest data, as first reported by the Globe. Is the private insurer, backstopped by taxpayers, hiding a public concern? Let’s take a quick dive into the issue, and you can let us know how you feel.  

Not Fluent In Mortgage Insurance? Let’s Fix That First

Let’s quickly clarify some terms so we’re all on the same page. The loan-to-value (LTV) is the ratio of a loan to the current value of the asset securing the loan. A mortgage with an LTV of 50% means the mortgage balance is 50% of a home’s value. The lower the LTV, the less risk for lenders—since they can recoup the loan with the value of the asset. Higher LTVs mean higher risk, since there’s less to recoup. 

An underwater mortgage is when LTV rises above 100%. Most defaults can be avoided if the borrower lists a home for sale before they fall behind on payments. However, an LTV above 100% means the borrower would have to pay to get out of their mortgage. An owner forced to sell due to distress probably doesn’t have a ton of cash kicking around to exit. This can result in those dreaded delinquencies, and losses to a lender. 

So who’s stupid enough to lend money to high LTV borrowers, and not charge a ridiculously high interest rate? There’s only ever one answer—taxpayers. In this case, it’s indirectly through Canada’s mortgage insurance program. Mortgages with an LTV of 80% or higher require insurance, which only pays out in the event there’s a loss on the sale of the property. There are 3 providers in Canada, including the state-owned CMHC that you’re likely most familiar with. However, two private companies also operate, with taxpayers ultimately backstopping them as well.

Mortgage insurance was originally rolled out to help with homeownership, and it worked. Lenders became much more comfortable lending money when there’s virtually no loss risk. It worked until right around the Global Financial Crisis (GFC). From that point on, low interest loans allowed investors to leverage up and try to capture the additional leverage that mortgage insurance provided. The loans might have been close to free, but there’s always a cost, am I right? 

Anyway, back to the Canada Guaranty situation that has raised some skepticism in the real industry.   

Canada Guaranty Stops Reporting Underwater Mortgages

Canada Guaranty recently ended its practice of disclosing its underwater mortgages. It last reported $4 billion in mortgages with LTVs greater than 100% in 2022. Starting this year, they’ve grouped it together with LTVs greater than 95%, coming in at about $15.2 billion in the Q2 2023 data just released. It’s unclear what share is over 100%, but it would be hard to see a significant reduction already. Especially with prices falling. 

Is it a concern? It depends what kind of concern. Let’s start with the positive case (I know, very unlike me). 

Reporting Underwater Mortgage Exposure May Not Matter

In terms of Canada Guaranty reporting LTVs 95% or higher, not really. Canada Guaranty is the smallest of the insurers, and the other two, including the state-owned CMHC, don’t report LTVs over 100%. Since a 95% LTV is the minimum for a mortgage origination, it still implies a loss of equity. The borrower won’t be able to move to another lender without paying up, and they are technically a concern for the insurer. However, it’s not an actual loss.   

Speaking of actual losses, it’s important to understand who walks away from their home. One of the few smart things Canada has done with housing is limit insurance to a primary residence. A mortgage is the last thing an end-user stops paying, since it’s where they live. End-users also tend to ride out negative equity, as observed during the Global Financial Crisis (GFC). This means negative equity may not represent the size of risk it presents. The extremely high-leverage investors using unregulated private lenders, and entertaining cash flow negative properties are a bigger concern. 

… But Underwater Mortgages Can Matter If It’s Bigger Than Thought

Now for the negative case—LTVs are junk. Heck, even execs at one of Canada’s Big Six banks said exaggerated property values have made LTVs for risk purposes unreliable. A squeeze and stimulus might have sent prices higher, but how sticky are those prices when conditions normalize? A rural property with an LTV of 90% to urban buyers during lockdowns, might look like 110% to a local market once they’re asked to return to the office. The mentioned exec stated their bank is focused on a borrower’s repayment ability in a downturn, not the value of the asset.  

In a downturn, taxpayers might be on the hook for an astronomical amount of money. Back in 2015, it was suggested the country put away $9 billion to cover mortgage insurance losses. Considering that home prices have more than doubled since, ripping over 60% within just two years, the amount would likely be much larger.

Ultimately, the biggest red flag is, why the sudden shift to no longer reporting it? It’s a certainty that they track it, so the concern about optics should set off alarms. The fact that the other two insurers don’t disclose doesn’t serve as relief. Rather it presents further concerns that policymakers are pushing taxpayers to back very profitable organizations they don’t understand.