Sub-Prime Mortgage Loans

Posted on March 17, 2020 by JRM

A New Narrative

A lot of ink has been spilled assigning liability for the financial crisis to sub-prime mortgage loans.The role of sub-prime mortgage loans was so prominent that it has been called the ‘sub-prime crisis’. But a recent study by the New York Federal Reserve Bank shows how wrong this conclusion is.

In a paper published on Liberty Street Economics, “Did the Subprime Borrowers Drive the Housing Boom?”, (https://libertystreeteconomics.newyorkfed.org/2020/02/did-subprime-borrowers-drive-the-housing-boom.html) the authors demonstrate quite clearly, for example, that inflated appraisals were not concentrated in sub-prime mortgages.

They also demonstrate that the boom in house prices and sub-prime mortgage loans occurred in different places (see the maps below). They show a clear negative correlation between house price appreciation and the sub-prime share of home purchase mortgages.

As the authors say, “Our analysis contributes to a ‘new narrative‘ that rapid U.S. house price appreciation during the 2000s was mainly driven by prime borrowers. Hence, policy prescriptions intended to limit access to credit for marginal borrowers may be insufficient by themselves to prevent a future housing boom.”

OSFI to Reconsider 4% Limit?

Posted on February 1, 2016 by J Marlatt

According to reports in The Cover and The Covered Bond Report, Canada is considering whether to increase the 4% limit imposed on covered bond issuance. This limit was imposed by the Office of the Superintendent of Financial Institutions (OSFI) at the inception of covered bond issuance by Canadian banks in 2007 and remains unchanged today. While the limit is the most stringent currently applied in the covered bond world, Canadian banks have nevertheless been active issuers of covered bonds as can be seen by the table below.

	US$	EUR	GBP	CHF	A$	C$
Issued (mm)^*	71,600	44,037	4,375	2,075	7,450	4900
Outstanding (mm)^*	39,600	38,613	4,375	1,400	5,100	3,300

Source: www.us-covered-bonds.com/cdn_issue_details
^* As of January 28, 2016.

The current 4% limit is measured as the Canadian dollar equivalent amount of covered bonds outstanding divided by total assets. The table below shows the covered bond issuance capacity remaining for each Canadian covered bond issuer as of December 2015.

	BMO	BNS	CCDQ^*	CIBC	NBC	RBC	TD	TOTAL
Total Assets (mm)^**	641,881	856,497	1,318	463,309	216,090	1,074,208	862,532	4,115,835
Maximum Amount (mm)	26,100	33,600	7,400	18,200	8,300	43,500	42,400	179,700
Outstanding Amount (mm)	11,600	22,200	5,400	10,700	7,300	31,300	20,900	109,400
Used Capacity	44.3%	66.0%	73.1%^*	59.0%	87.8%	71.6%	60.9%	60.9%
Remaining Amount (mm)	14,500	11,400	2,000	7,500	1,000	12,400	21,500	70,300

Source: CMHC, Covered Bond Business Supplement, September 2015.
^*Note that CCDQ is subject to a different limit, which is set by Autorite&#769 des marche&#769s financiers at EUR 5.0 billion.
^** As of October 31, 2015.

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Reg AB II and Covered Bonds

Posted on October 8, 2014 by J Marlatt

Updated: 12/28/2015

The United States Securities and Exchange Commission (the “SEC”) adopted revisions to Regulation AB on August 27, 2014, after a four year process of proposals and review. Regulation AB is the rule that governs the offering disclosure and periodic reporting obligations of issuers of asset-backed securities (“ABS”).

Insofar as covered bonds are concerned, several things are clear. First, covered bonds are not included in the definition of “asset-backed security.” Item 1101 of Regulation AB provides that:

Asset-backed security means a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases.

It is clear that covered bonds are not “primarily serviced by the cash flows of a discrete pool of receivables or other financial assets.” Instead, covered bonds are senior obligations of the issuing financial institution and are expected to be repaid from the general funds of the institution. Accordingly, covered bonds should not be asset-backed securities and Regulation AB should not apply generally to covered bonds.

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BNS Files U.S. Prospectus

Posted on August 20, 2014 by J Marlatt

BNS initially filed its registration statement for its legislative covered bond program on Form F-3 with the SEC on May 31, 2013. That registration was declared effective on September 9, 2013. However, BNS did not file a prospectus under the registration statement with the SEC until today, August 20, 2014. In the interim, BNS filed a prospectus with the UKLA and offered covered bonds in Europe on March 26, 2014. Now, with the filing of a prospectus with the SEC, BNS is ready to offer covered bonds in the U.S.

Year to date, the U.S. covered bond market has been very quiet. Only two issuers have brought bonds to market for a total of $3 billion: Westpac Banking Corp. on May 14 and Commonwealth Bank of Australia on June 14, both privately placed offerings. So far, no registered covered bonds have been issued in the U.S. in 2014.

Moody’s expects lower predictability of government support for Canadian banks; changes banking system outlook to negative

Posted on July 16, 2014 by J Marlatt

On July 8, Moody’s followed up on its June 11 announcement regarding risk related to a “bail-in” regime in Canada with an announcement of the change to “outlook negative” in Global Credit Research. Additionally, Moody’s notes that “high household indebtedness and elevated housing prices remain key risks to banking system stability in Canada”. Further, Moody’s states that “growth sought by the banks has led them to diversify into riskier businesses and geographies which dilute their strong domestic credit profiles and represent a growing risk to the Canadian system’s stability”.

Moody’s: Canadian Banks on Outlook Negative

Posted on June 12, 2014 by J Marlatt

On June 11, 2014, Moody’s Investors Service changed the outlook of the seven largest Canadian banks from stable to negative and confirmed each of their long-term ratings. Moody’s stated that the action was taken in response to previously announced plans of the Canadian government to implement a “bail-in” regime for Canada. In Moody’s view, the balance of risks for senior debt holders and uninsured depositors of Canadian banks “has shifted to the downside.”

This rating action by Moddy’s has not affected the rating of any outstanding covered bonds issued by the banks. The current long-term ratings of the banks by Moody’s range from Aa3 to Aa1.

More on Canadian Housing Prices

Posted on February 25, 2014 by J Marlatt

The Wall Street Journal reports in its February 19, 2014 paper that the campaign to prevent a housing bubble is gaining traction. They report that many observers think the market is drastically overpriced and may be subject to t sharp correction. The article reports that housing prices have doubled since 2002 and rose 9.5% in January compared to January 2013. A chart shows average house prices in Vancouver at more than C$800,000 and in Toronto at more than C$500,000. House prices are reported to be 50% above those in the U.S. And the construction industry is reported to represent twice the percentage of the gross domestic product in Canada as in the U.S.

As noted elsewhere, however, this is not a repeat of the subprime mortgage debacle we had in the U.S. Canadian residential mortgage loans have much lower loan-to-value (LTV) ratios and are full recourse, so the borrower is unable to just turn over the keys and avoid the debt. But these comparative numbers would suggest that Canadian consumers are carrying high levels of housing related indebtedness. Small wonder that Canadian consumers are reported to have debt to asset ratios close to those of U.S. homeowners prior to the crisis. And most of that asset value is from overpriced houses. A sharp correction in housing prices would hit consumers hard.

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