The same type of debt blamed in the U.S. credit crisis could help Canada with housing risk

The type of securities blamed for triggering a credit crisis in the U.S. a decade ago could now be part of the solution in Canada, where a cooling housing market is a key risk to its $1.7 trillion economy.

“While lenders are very well equipped to manage normal market risks, I suspect they are rather unwilling to take on the additional risk of future government intervention in the housing markets,” said Andrey Pavlov, a professor of finance at Beedie School of Business of Simon Fraser University in Greater Vancouver.

Longer TermThe notes are repaid as borrowers pay down debt. The legal duration of the bonds could be significantly longer than the expected repayment rate suggests. This could be a useful tool for lenders to offer longer-term mortgages in a country where most of the home loans have a 5-year term. The repayment of the bonds can be adapted to the repayment of the underlying collateral.

The Canadian Fixed-Income Forum, a Bank of Canada-led group made up of participants in the bond market, has been working since at least last year to analyze the conditions and incentives that would be required to expand interest in the asset class, according to the minutes of their meetings. It conducted a focus group last month with mostly buy side institutions about the disclosure on the underlying collateral and other features they may require.

The starting point of RMBS as a funding tool isn’t the most attractive for banks as investors may demand an extra yield of 20 to 30 basis points over their senior bail-in debt in a stable market situation, said Chaudhry, who is part of the CFIF. Yet, once a market develops the spreads will tighten and it will make economic sense for the lenders to issue, he said.

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