Bank of Montreal is bundling uninsured residential mortgages into bonds in what could be the start of a new financing market for Canadian banks as the government scales back its support for home loans.
The Toronto-based lender is planning to sell debt backed by nearly C$2 billion ($1.5 billion) of prime uninsured mortgages. That's a new development in a country where big banks have historically packaged government-insured mortgages into bonds.
If the Bank of Montreal deal is successful, other Canadian banks may follow its lead, providing banks with more financing to keep making mortgages, said Marc Goldfried, chief investment officer at Canoe Financial. The net result may be that housing prices in Canada keep rising.
"Right now the banks don't have any other way to fund it, so there's probably some form of internal limit on this kind of mortgage financing they'll do," Goldfried said by phone from Toronto.
But the Bank of Montreal deal may find headwinds, said Paul Gardner, partner and portfolio manager at Avenue Investment Management Inc. Canada last year tightened access to the federal insurance to help tamp down rapid home price growth in areas like Toronto and Vancouver. The federal government or Ontario could craft more legislation to cool the housing market, Gardner said.
The province's finance minister is considering a foreign-buyers tax like the one that helped cool home prices in Vancouver. Canadian finance minister Bill Morneau, Ontario finance minister Charles Sousa, and Mayor John Tory are meeting in Toronto Tuesday to discuss the housing market in the Greater Toronto Area.
"Residential mortgages, my God, it's the last thing you want to invest in right now," Gardner said by phone from Toronto. "When the capital markets are flush with cash, it makes sense that they would try at least to issue this stuff."
Gardner said has not looked at these particular securities.
Canadian banks have used covered bond programs and asset-backed commercial paper programs to securitize mortgages that do not carry government insurance, but have yet to issue term residential mortgage-backed securities unless they were through a government-sponsored program.
The Bank of Montreal bond is backed by C$1.96 billion of prime residential mortgages, more than half of which are in Ontario and Quebec, according to a Moody's presale report. Around 95% of the securities in the transaction will be rated Aaa. The lowest rated portion will be B2, and there is a nonrated portion as well, the bond grader said. Representatives for Bank of Montreal were not immediately available for comment.
"This is a really unique deal in the Canadian market," Richard Hunt, an analyst at Moody's Investors Service who rated the deal, said in an interview. "Given the pent-up demand that we think is out there on the part of banks and nonbanks to have a vehicle to fund their residential mortgages, to have an RMBS market, we think this could be a significant transaction."
The bank will offer to renew the mortgage loans at the end of their term if the borrower is not in default, and if the borrower satisfies the bank's underwriting criteria at the time, which mitigates some of the risk of borrowers not being able to refinance. Canadian mortgage loans generally have a five-year term, and borrowers pay down their principal at a 25- to 30-year pace meaning they usually have to refinance a significant portion of their loan every five years.