Canadian Insurer Halts Underwater Mortgage Data Disclosure: Cause for Alarm?

In a surprising move, one of the titans of Canadian mortgage insurance, Canada Guaranty, has stopped publicly sharing details of its underwater mortgage exposure. The Globe was first to break this news. The burning question is: With a taxpayer-funded backup, is this insurer masking a looming public issue? Let's unpack this for a clearer understanding.

A Primer on Mortgage Insurance: Let’s Break it Down

For those unfamiliar with the nuances of mortgage insurance, here's a brief explanation. The loan-to-value (LTV) ratio indicates the relationship between the loan amount and the current value of the asset securing it. A 50% LTV, for instance, denotes that the mortgage is half of a property's total worth. The rule of thumb? Lower LTVs signify lesser risks for lenders, as they can retrieve the loan amount from the asset's value. On the flip side, greater LTVs amplify risks due to decreased recovery chances.

An LTV exceeding 100% is termed an underwater mortgage. While the majority of default situations can be bypassed if homeowners sell before failing on payments, exceeding 100% LTV implies homeowners would have to spend more to settle their mortgage, potentially leading to delinquencies and lender losses.

Now, who would grant loans to high LTV recipients without levying exorbitant interest rates? The answer invariably points towards taxpayers, indirectly via Canada's mortgage insurance program. If LTVs are 80% or above, insurance becomes mandatory. The state-owned CMHC is perhaps the most recognized of the three available providers in Canada, with two additional private entities in operation.

Mortgage insurance, initially conceptualized to promote homeownership, has successfully instilled confidence in lenders due to the minimized loss risk. However, the dynamics changed post the Global Financial Crisis (GFC). While the loans almost seemed free, the true cost was lurking underneath.

A Closer Look at the Canada Guaranty Move

Till last year, Canada Guaranty reported underwater mortgages amounting to $4 billion (with LTVs over 100%). Fast forward to this year, they've merged this category with LTVs above 95%, reporting a cumulative $15.2 billion in Q2 2023. The proportion exceeding 100% is yet unclear, especially amid dipping prices.

Is this alarming? Let’s inspect both sides of the coin.

Underwater Mortgage Reporting: Is It Crucial?

From Canada Guaranty's perspective, perhaps not. Being the smallest of all insurers, its actions don't necessarily mirror larger players like CMHC, which don't reveal LTVs over 100%. Given 95% LTV is the initiation benchmark, a loss of equity is inherent. It signifies a challenge for the insurer, albeit not a tangible loss.

Nevertheless, in Canada, insurance is limited to primary homes, a strategic decision that ensures homeowners prioritize their mortgage payments. This stance was validated during the GFC, implying negative equity might not epitomize the risk it suggests. The actual concern arises from high-leverage investors engaging with unregulated private lenders.

Yet, the Implications Can Be Grave If Misjudged

On the downside, LTVs might not be trustworthy. As highlighted by an executive from one of Canada's Big Six banks, inflated property estimates have rendered LTVs as unreliable risk indicators. With housing prices skyrocketing by over 60% in just a couple of years, the fiscal reserves from 2015 might prove insufficient.

The most pressing concern? The abrupt halt in reporting underwater mortgages by Canada Guaranty. Given they certainly maintain these records, this move can be perceived as an alarming signal. The nondisclosure by other insurers is no consolation, suggesting potential risks the taxpayers might be unknowingly underwriting.

Mortgage insurance, while designed to facilitate homeownership, carries underlying risks. With the recent shift in Canada Guaranty’s reporting strategy, it’s crucial for policymakers and stakeholders to comprehend the broader implications, ensuring both homeowners and taxpayers are protected from unforeseen circumstances.