Recent Developments in the Canadian Residential Mortgage-Backed Securitization Market
The Canadian mortgage securitization market has experienced significant growth recently through the securitization of ‘non-conforming’ residential mortgages.
A conforming residential mortgage is a residential mortgage originated using lending criteria traditionally applied by the major Canadian banks, such as the mortgage is secured against a residential property with a loan-to-value ratio that does not exceed 75 per cent. These mortgages are commonly referred to as ‘A’ mortgages.
Alternatively, a non-conforming residential mortgage is a residential mortgage that does not satisfy those traditional lending criteria. Reasons for this non-conformity may include:
- income is difficult to verify or predict as a result of the borrower being self-employed or paid on a commission basis;
- the mortgage is secured against a second residence or a recreational or cottage property; or
- the mortgage is secured against a residential property with a loan-to-value ratio in excess of 75 per cent. Non-conforming residential mortgages are commonly referred to as ‘Alternative A’ or ‘Alt-A’ mortgages.
A sub-category of non-conforming residential mortgages are commonly referred to as ‘sub-prime’ mortgages. These mortgages typically involve borrowers with (i) prior bankruptcies, (ii) credit histories that contain delinquent mortgage or consumer debt payments (or both) or (iii) credit scores that fall below certain thresholds.
Over the past several months, three key developments have occurred in the Canadian non-conforming residential mortgage-backed securitization market. First, fixed interest rate or ‘bullet’ interest rate non-conforming residential mortgage-backed securities were publicly offered in Canada for the first time. Prior to this offering, all public offerings of non-conforming residential mortgage-backed securities were ‘pass-through’ securities in which all funds received in respect of the pool of mortgages pass through the issuer to the security holders. Secondly, this market recently gained its second public issuer of non-conforming mortgage-backed securities. The first Canadian public issuer of such securities completed four public offerings of such securities in Canada prior to the entry of this recent competitor.
Many participants in this market believe that it will continue its impressive growth due to the ongoing strength of the Canadian housing market. As well, the entry of new participants in this market, such as U.S. originators that have established operations in Canada and several of the major Canadian banks, bodes well for continued growth. One originator of non-conforming residential mortgage loans in Canada recently estimated that this market could increase to 10 per cent of the Canadian residential mortgage market, or $50 billion.
Lastly, the first note-insured or ‘wrapped’ non-conforming residential mortgage-backed securitization recently occurred in Canada. In this transaction, an insurance company guaranteed the timely payment of interest and principal on a note that was secured by a pool of non-conforming residential mortgages. This insured note was then sold on a private placement basis to a Canadian bank-sponsored issuer of asset-backed commercial paper.
As this market continues to grow, new structures and types of non-conforming residential mortgage-backed securities offerings are likely to be seen in Canada.