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Research

MIC - Genworth Canada announces potential impact of recent Government of Canada changes to the
mortgage market
Sentiment Indicator : negative
ProducedbyKwan,Geoffrey(RBCDominionSecuritiesInc.)onTuesday,October04,2016,11:14AMET
DisseminatedonTuesday,October04,2016,11:20AMET

Summary: Genworth Canada provided some colour on the potential impacts from yesterdays announcement from the Canadian Government on changes to
borrower requirements for insured mortgages, changes for portfolio insured mortgages, as well as the announcement of a formal industry consultation on
mortgage insurer-lender risk sharing.

Based on 2016 YTD data, new mortgage rate stress testfor all insured mortgages would put 1/3 of transactionally insured borrowers would have
difficulty meeting new debt service ratios. Effective October 17, 2016, all insured homebuyers must qualify for mortgage insurance at an interest rate that is
the greater of their contract mortgage rate (market rate) or the Bank of Canada's conventional 5-year fixed posted rate, which is currently 4.64%. This
requirement is already in place for high-LTV insured mortgage borrowers who chose variable interest rate mortgages or fixed interest mortgages with terms <5
years. In other words, the 5-year fixed rate mortgage was effectively the only mortgage type where highly qualified borrowers were still qualified at the
discounted mortgage rate of ~2.50% (although lower rates are available), not 4.64%. The reason this is important is the 5-year fixed rate mortgage is the most
popular in Canada (according to Mortgage Professionals Canada surveys historically, the 5-year fixed rate mortgage might comprise about 2/3 of mortgages in
Canada). To qualify for mortgage insurance, debt-servicing ratios cannot exceed the maximum allowable levels of 39% and 44%, for Gross Debt Service ratio
and Total Debt Service ratio, respectively.

Based on 2016 YTD data, new rules for portfolio insured mortgages would make 50-55% total portfolio insurance ineligible. Effective November 30,
2016, mortgage loans that lenders insure using portfolio insurance and other discretionary low loan-to-value mortgage insurance must meet the eligibility criteria
that previously only applied to high-ratio insured mortgages. New criteria for low-ratiomortgagestobeinsuredwillincludethefollowingrequirements:

l Aloanwhosepurposeincludesthepurchaseofapropertyorsubsequentrenewalofsuchaloan
l Amaximumamortizationlengthof25years
l Amaximumpropertypurchasepricebelow$1,000,000atthetimetheloanisapproved
l For variable-rate loans that allow fluctuations in the amortization period, loan payments that are recalculated at least once every five years to conform to
theoriginalamortizationschedule
l Aminimumcreditscoreof600atthetimetheloanisapproved
l A maximum Gross Debt Service ratio of 39 per cent and a maximum Total Debt Service ratio of 44 per cent at the time the loan is approved, calculated
by applying the greater of the mortgage contract rate or the Bank of Canada conventional 5-yearfixedpostedrateand,
l A property that will be owner-occupied.

Lender risk sharing consultation underway but still in very early stages. The government also announced yesterday the launch of a public consultation on
the potential to introduce mortgage insurer-lenderrisksharingofsomeform.

Our initial take: Negative. In terms of initial thoughts, we think the following:

l AnetnegativeforhighLTVnewpremiumswritten.Despite our expectation that prices will increase in the high LTV mortgage insurance market
and that some borrowers that still qualify under new rules are likely to still purchase homes, there are likely a significant number of borrowers that are
unable to qualify and net-net, it is the "loss" of borrowers that qualified under prior rules that is likely to outweigh a potential price increase.
l AslightnetnegativeforlowLTV(bulk/portfolio)insurancenewpremiumswritten.We think the combination of last week's OSFI mortgage
insurer capital requirement changes and yesterday's Canadian government announcement is very likely to lead to a significant increase in bulk/portfolio
insurance pricing. In our view, bulk/portfolio insurance pricing could double or even triple based on OSFI's higher capital requirements alone. We think
these changes are likely to be net negative to new low LTV premiums written as likely reduced demand is likely to be only slightly offset by higher
prices, although it is possible that the impact could be neutral as we think there is a base demand level for bulk insurance given lenders/originators need
insured mortgages to securitize via CMHC's securitization programs (these programs require all mortgages to be insured and after bank deposits, offer
the lowest cost of funding for mortgage lenders).
l Price increases are almost certainly a given and likely to be very significant, BUT a price increase itself would be highly unlikely to
materiallyimpactthehousingmarket.As noted above, mortgage insurance pricing are highly likely to increase, but the reason that it is unlikely to
materially impact the housing market is because the cost of the mortgage insurance is added to the mortgage loan amount and amortized over (typically)
25 years, so the per month increase in mortgage costs is likely to be minimal (prior price increases of 10-15% each only increased typical monthly
mortgage payments by only ~$5).
l In the short term (Q4/16 and probably Q1/17), new premiums written arelikelytobeweakas home sales activity is likely to slow significantly as
buyers and sellers digest the recent changes.
l Recent changes have sought to effectively curb demand, but will there be a supply-side response and if so, in what form? The recent OSFI
changes on mortgage insurance capital requirements and yesterday's Federal Government changes should slow housing/mortgage demand. What
remains unclear is whether there will be changes to help increase supply, particularly in cities like Toronto and Vancouver, to address affordability issues
especially those that still qualify under the new mortgage rules. This could be a slight partial offset (by driving home sales activity), but it will be
dependent on the mix of new supply between for sale vs. rental (the former being more beneficial for residential mortgage lenders/originators/insurers,
with the latter being less beneficial).
l Biggerpicture,thesechangesseektolimittheriskofaseverehousingdownturnandmortgageloanlosses.While it's unclear whether these
changes slow down the market more than intended, we believe these changes seek to curb some of the overheated activity in large urban areas like
Toronto and Vancouver, but also improve the system for longer-term stability.
l Risk sharing impact is unclear but could be a positive. The concept of risk sharing has been mentioned for a couple of years now, so we do not view
this announcement as unexpected. It is still very early stages and it's unclear what form it could take but directionally it could be positive for mortgage
insurers if it lowers their loss ratio, but will be contingent on the form of risk sharing, the impact on mortgage insurance pricing and capital requirements.

Company Name Exchange Ticker Rating Risk Qualifier Price Target Currency Price Price Date

Genworth MI Canada Inc. Toronto SE MIC.TO Sector Perform Not Assigned 36.00 Canadian Dollar 32.60 04 Oct 2016 10:36:11 ET

RBC Dominion Securities Inc.


Geoffrey Kwan (Analyst)|(604)257-7195|geoffrey.kwan@rbccm.com
RBC Dominion Securities Inc.
Charan Sanghera (Senior Associate)|(604)257-7657|charan.sanghera@rbccm.com
Lisa Stewart (Associate)|(604)257-7662|lisa.k.stewart@rbccm.com

Click here for conflict of interest and other disclosures relating to Genworth MI Canada Inc., Geoffrey Kwan These disclosures are also available by sending a written
request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7 or an email to
rbcinsight@rbccm.com

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