The nearing of Canada Mortgage & Housing Corporation to a C$600bn cap on mortgage insurance could hit the Canadian covered bond market, Fitch said yesterday (Monday), with issuers potentially having to set up new programmes for uninsured assets and affecting a proposed legislative 10% OC cap.

CMHC headquarters, Ottawa

The Canadian crown corporation was C$59bn short of this limit as of the end of September 2011, having reached C$541bn, and although the Canadian parliament has, according to Fitch, steadily raised CMHC’s capacity from C$200bn prior to 2006, further increases are not guaranteed.

“While CMHC can petition the government for another increase, an expansion of the insurer’s balance sheet is unlikely as it would contradict recent steps – i.e. tightening lending standards – taken by the Minister of Finance to curb mortgage lending,” said the rating agency.

According to Fitch, Canadian banks have since 2008 issued roughly C$40bn of covered bonds backed by CMHC insured assets, the majority of these covered by discretionary lender-paid bulk policies. The rating agency said that issuers are likely to have sufficient insured assets to cover existing covered bond obligations, but was less confident about the future.

“Reduced access to bulk insurance could potentially affect future covered bond issuance as allocations of more cost-effective NHA-MBS (National Housing Act mortgage-backed securities) become sufficient to meet banks’ funding needs for diminishing amounts of insured mortgages,” said Fitch. “Covered bond issuance has generally been pursued to finance insured loans after issuers have reached their limit of NHA-MBS.”

The rating agency said that this could force banks to use uninsured mortgages as covered bond collateral, but that potential resistance from trustees to amending existing programmes could mean that new programmes have to be set up. The higher credit and market value risks that uninsured assets would be subject to would lead to “considerably higher” levels of overcollateralisation (OC) being necessary, said Fitch.

“Increased OC commitments for programmes secured by uninsured mortgages, resulting from increased credit and market value risk, also challenge the sufficiency of the 10% OC cap contemplated by the Department of Finance [in] Canada’s covered bond legislation proposal,” said Fitch. “OC levels for existing programmes are within the 10% range, but it is conceivable that weakening housing market conditions could push levels higher in the absence of insurance protection.”