Ottawa to buy up to $50-billion in mortgages in move that harkens back to the crisis of 2008
In response to the COVID-19 virus pandemic, the federal government said Monday that it is preparing to buy up to $50 billion of insured mortgage pools through the Canada Mortgage and Housing Corporation (CMHC).
Ottawa said the move is “immediate, significant and effective action” to support Canadians and businesses facing financial hardship as a result of the pandemic and its impact.
“This action will provide stable funding to banks and mortgage lenders in order to ensure continued lending to Canadian consumers and businesses,” the government said in a statement, adding that it is meant to enhance other measures unfurled last week, which included an interest rate cut and easing up on the size of the capital cushion banks must maintain.
Ottawa stepped in with a similar program during the 2008 financial crisis. The Canadian government did not buy soured mortgages, as was done in the United States. Instead, the idea is to give the big banks funding and liquidity flexibility so they could provide cash and credit to individuals and businesses, as needed, to keep the economy going.
“As insured mortgage pools in Canada already carry Government of Canada backing, there is no additional risk to taxpayers,” the statement issued late Monday said, noting that the purchased insured mortgage pools will earn a rate of return for the government that is above its own cost of borrowing.
Details of the terms of the purchase operations will be provided to lenders later this week, and will be done under a revised insured mortgage purchase program.
“During the (2008) crisis these measure were found to be very effective,” said Jason Mercer, a senior analyst at Moody’s Investors Service.
Mercer said the central bank is creating “a pretty strong arsenal” with Monday’s moves coming on top of earlier steps, including urging the big banks to suspend dividend increases and share buybacks.
What may be different this time, however, is the impact the novel coronavirus and its fallout will have on credit quality of the banks’ portfolios.
“It’s still early days,” said Mercer. “There will likely be a rise in unemployment that will cause loan defaults,” Mercer said.
While there was an increase in defaults during the 2008 financial crisis, the unemployment rate remained lower than in previous recessions, he noted.
With businesses in many sectors now shutting down and steeply reducing their output – from airlines to restaurants — a higher unemployment rate could trigger a greater volume of defaults on mortgages, lines of credit, and credit cards, even as the government steps in with provisions to help workers weather the impact of the novel coronavirus.
“As unemployment creeps up, loans will default and start eating into banks’ capital,” Mercer said.
Business loans are also a concern, though some financial institutions such as credit union Desjardins are offering to be flexible on a case-by-case basis.
The Canadian Federation of Independent Business says half of Canada’s small firms have already seen a drop in sales due to fallout from the novel coronavirus and steps to slow its spread, and a quarter would not be able to survive for more than a month with a 50 per cent decline in business.
For financial institutions, new supports put in place in the aftermath of the 2008 financial crisis should kick in to dull the impact of defaults, if needed, Mercer said.
“(Bank) capital ratios are much stronger today than they were during the last crisis. If borrowers stop paying today, it will take a quarter for delinquencies to start and about six months for write-offs to occur and start eating into capital buffers,” Mercer explained.
If that happens, and “capital buffers start to run thin, we’ll likely see other government actions to potentially recapitalize the banks,” he added.
For instance, the conversion of bail-in loans could be activated. The bail-in loan is a financial vehicle for institutional investors that created after the 2008 financial crisis to avoid taxpayer-financed bank bailouts by the government.
Bail-in debt is convertible, with a trigger that converts the debt securities into shares to allow a bank that is in danger of collapsing to continue operating. The conversion relieves the bank of the debt and shores up its capital position.