Looser capital rules free up banks' cash

Thursday, August 8, 2013


Canada's banking watchdog is relaxing the capital rules it imposes on financial institutions that package their mortgages for sale to investors. The Office of the Superintendent of Financial Institutions has ruled that banks and smaller lenders are no longer required to include loans that are securitized as National Housing Act mortgage-backed securities when calculating their total risk-weighted assets.

Because securitization offloads risks to investors, OSFI said that packaged mortgages no longer need to sit on lenders' balance sheets, sucking up capital. Lenders must adhere to rules that state their assets can total no more than 20 times their underlying capital, and with fewer assets on their balance sheets, they can free up cash to make more loans or invest in other areas of their businesses, without breaching this limit.

OSFI's ruling updates regulations that were in place prior to 2010 and were altered in 2011 when new international accounting rules were implemented in Canada. But it is hard to determine just how much the market will change following the reversal. "The implications are unclear," said analyst Peter Routledge at National Bank Financial, adding that the specific rules are relatively nuanced.

While he acknowledged it should become easier for lenders to sell new mortgages, Canada Mortgage and Housing Corp. recently announced that it would limit the value of mortgage insurance that financial institutions can apply for each month. The four largest banks are already approaching this limit and may not be given much additional room, meaning they won't be able to sell more mortgages.

Mr. Routledge said that the OSFI ruling "seems to be a little bit at odds with what the government wants," considering that the federal finance department and CMHC have been trying to cool the country's housing market.

Mortgage lender Home Capital has been a major proponent for reversing the rules to the old standards, when securitized mortgages didn't count in capital calculations.

Although Home Capital is much smaller than the big banks, president Martin Reid said in an interview that it was one of the first financial institutions to be hit by the rule changes in 2011 because their fiscal year came months before those of the banks, requiring the lender to comply with the new capital rules much earlier.

Mr. Reid said smaller lenders are more affected by the rules because their balance sheets are much smaller than the banks', and securitized mortgages therefore comprise a bigger chunk of total assets.

Before the 2011 rule change, Home Capital originated about $350-million a month of prime insured mortgages, or high-quality mortgages that come with insurance from CMHC or a private company. Today, Home Capital originates just $50-million a month of these mortgages, Mr. Reid said, because the profits on these types of mortgages aren't very high after the lender was required to hold a lot of capital against them.

The new rules mean it will make more economic sense for Home Capital to lend to safer borrowers, instead of relying on bigger profit margins made from lending to what are known as Alt-A households, or riskier borrowers who have a higher chance of defaulting.

Mr. Reid said that the rule change should help his company increase mortgages sales because Home Capital uses mortgage brokers to find new clients. Many of these brokers, he said, will only bring lenders Alt-A customers if they can also bring prime insured clients at the same time.