PL RMBS Prospects Are Looking Up – Up North, That Is: Part 2

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The housing collapse in the U.S. that began in 2007 was of epic proportion, and scale. By 2010, prices had fallen more than 35% from their peak in some states while some of the poorest cities in the U.S. saw home values fall to near zero. The reason for this collapse was simple and doesn’t require an advanced degree in mathematics to fully grasp. When a borrower buys a home with little to no money down, and in doing so,  fabricates their ability to maintain that asset, it only takes a minor hiccup in the market, for that "house of cards" to come tumbling down.

This however, was not the case in Canada. While the Canadian housing market did in fact suffer a crisis of its own, it was more a liquidity crisis than a true housing collapse. Canadian lenders — and investors — never fully embraced the no-money-down concept like in the U.S. and as a result never experienced the same decline in home prices or loss severities. Similar to the U.S., Canada also saw home values rise to historic high levels, but when non-government guaranteed loans carry an average loan-to-value ratio of 66%, and appraisals, income levels and assets are fully verified; the risk of a significant decline in home values, becomes greatly diminished. Furthermore, when all parties to a mortgage transaction (borrower, lender, regulator, servicer, appraiser, lawyer, etc.) understand their role and play within permitted parameters; the system functions properly. When the integrity of the asset, the notion of layered risk, the sanctity of the mortgage contract and the rule of law, prevail; the long-term transfer of risk becomes possible.

Therein lies the fundamental difference between the U.S. and Canadian housing markets. Allowing for the blind transfer of risk into the capital markets in the United States fueled much of housing’s price increases in the years leading up to the collapse. Tracking the growth of median household income against the rise in median home prices since 1967 reveals lockstep and near identical growth trajectories for approximately 35 years before a sharp divergence begins to take place in 2001. Furthermore, overlaying the emergence of no-money-down/stated documentation loans and the issuance of RMBS over that same timeline shows how home sales rose and fell in line with these non-agency products, which created in a housing boom that ended with a bust few predicted. This has left the U.S. with a market in which there has been virtually no new, private label RMBS issuance since 2009.

Canadian regulators and banks have always taken a proactive (some say "obsessive") approach to managing risk in their housing market. They don’t wait for the pendulum to swing too far in either direction before looking to effect a change. Even at the earliest signs of a "perceived" bubble, Canadian regulators, investors and markets, begin to react. Steps are taken as government-backed mortgage insurance allocations are curtailed and industry guidelines are tightened. Even "quasi-regulated" private mortgage lenders begin their own policing process of self-regulation by raising the "mortgage qualification" bar. Investors in Canada are inherently risk averse and lenders are sensitive to that aversion.

After spending the past six years studying the adverse effects of negative equity on housing and the use of financial incentives on consumer behavior; one thing is irrefutable: Negative equity has been — and will always be — the main driver of mortgage default. The housing markets in many countries across the globe are the key drivers of their economy. As such, it would stand to reason that every effort should be taken to support and protect the long-term growth of that asset.

But even the best laid plans can go awry. Sometimes taking all the right precautions, at precisely the right time,may simply not be enough to stave off an increase in delinquency and default rates. Here again is where the U.S. and Canada differ dramatically, and what most investors view as the main deterrent to Private label RMBS issuance in the U.S. The regulatory and legal environment that exists in Canada gives the lender and investor comfort that their overall interests are being protected which in turn, greatly minimizes severity levels.The Canadian foreclosure and asset liquidation processes have been — and remain — both investor-friendly, and borrower-centric,leaving little doubt which country has the model for future growth in a new mortgage paradigm.

Lenders in the U.S. today — by choice and by edict — play by a new set of rules. Unfortunately, there was a relatively recent period of time where this was not the case. That lapse in judgment and misalignment of interests left a negative impression on U.S. institutional investors that will adversely affect the U.S. housing and residential securitization market for some time. Conversely, Canada has always played by these rules. Their strict adherence to common sense underwriting, a regulatory system that abides by contract law, and borrowers who understand that owning a home will always be considered more of a privilege than an entitlement, makes Canada the perfect place to (re)launch a residential PLS platform.