‘Orphan mortgages’ begin to surface

 John Greenwood, Financial Post   

 Rod and Joyce Marentette bought their house in Chatham, Ont., a month before getting married in 2005. The economy was booming and credit was plentiful, so even though they didn’t have a down payment and Rod had recently gone through a bankruptcy, there were plenty of mortgage companies willing to lend to them.

 

The house was $98,000 and with the additional legal fees the total price came to $100,000, all of which they were able to borrow from the mortgage company.

 

Things took a turn for the worse when Rod, who is 39, suffered a workplace injury and had to leave his job as a factory supervisor. But Joyce, 40, was determined to hold on to the house, taking on extra work to make ends meet. When Rod finally recovered two years later, he found a new job with a construction company. While the paycheque was lower, it took the financial pressure off.

 

That’s when they got the call from the mortgage company. It was the year the credit crunch hit. The economy was in a tailspin and lenders around the world were scrambling for liquidity. The mortgage, they were informed, could not be renewed and as the company was closing its subprime business, they would have to find another lender.

 

But the little lenders who had been so eager for their business back in 2005 had disappeared. That left the big banks and insurance companies, but they wouldn’t lend either and the Marentettes quickly realized their dream of owning a home was about to become a nightmare.

 

It ends up that despite its squeaky-clean financial image, Canada does indeed have its own subprime-mortgage mess.

 

Industry insiders say that over the next few years the Marentettes’ story will play out over and over again across Canada, as an estimated 30,000 so-called “orphan mortgages” reach maturity. Unless the government takes action, this may trigger a flood of foreclosures.

 

In the wake of the financial crisis, the business of subprime loans has dried up. Prior to 2007, there were at least a dozen subprime lenders in Canada and it was the fastest-growing sector of the entire mortgage market, says Benjamin Tal, senior economist at CIBC World Markets, who pegged it at about 5% of the total market.

 

But most of those lenders, including players such as Xceed Mortgage Corp., GMAC Residential Lending and Wells Fargo, have either changed their business or closed up shop.

 

Meanwhile, the rules around home loans have been tightened. Earlier this year, the federal government raised the minimum down payment required for Canada Mortgage and Housing Corp. insurance.

 

The mortgage industry clearly has a problem on its hands.

 

“This thing is a wave and it’s just starting,” says Eric Putnam, formerly with a subprime lender, now managing director of Debt Coach Canada, a company that provides financial and bankruptcy advice to consumers.

 

Estimates vary on the total value of the subprime market in Canada.

 

No one knows for sure how big it really is because there is no central database tracking these mortgages.

 

But according to Ivan Wahl, chief executive of Xceed, one of the biggest players in Canada until it recently converted to a bank, the subprime market in this country grew to about $11-billion in 2006, the year before things started to implode.

 

Given that the total mortgages outstanding in Canada amount to around $1-trillion today, the subprime portion is not a huge slice.

 

But the vast majority were made toward the middle of the decade with terms of three and five years and they’re coming due over the next two years.

 

“Given the current environment it will be very difficult to finance these [people],” says Mr. Tal, who calls it “a big problem for specific borrowers but not one from a macro perspective.”

 

But the industry is so concerned about the situation that it recently approached the federal government with a request for a bailout.

 

According to Mr. Putnam and others, it wants the federal government to participate in a $1-billion fund to help finance the coming flood of orphan mortgages.

 

During the credit bubble, subprime lenders funded themselves through the asset-backed commercial paper market.

 

The loans they made were packaged up and sold to securitization pools and then to investors in the form of ABCP.

 

But when the commercial paper market froze up in the financial crisis, lenders were suddenly left without a way to fund their businesses.

 

“Investors are no longer willing to continue on and these mortgages were not insured by the Canada Mortgage and Housing Corp., so the borrowers are not going to be able to move to another lender in today’s environment,” Mr. Putnam says.

 

The definition of subprime depends on who you ask, but for practical purposes the term generally refers to high-interest loans made to people who are unable to get a better deal at one of the big banks. Many such borrowers are simply self employed entrepreneurs but a good part are people with bad credit histories.

 

In the United States, the subprime market took off in the run-up to the crisis, growing to more than 20% of total mortgages outstanding as the loans were packaged up into complex securities and sold to investors around the world. When real estate prices finally started to crumble the value of the securities cratered, ultimately destabilizing the global financial system.

 

Analysts say it’s difficult to draw comparisons between the U.S. subprime market and what happened in Canada. The market here never grew to more than a sliver of the total and, more important, the type of loans offered by Canadian players were more conservative than those offered by their peers south of the border.

 

But there are nevertheless some disturbing parallels between the two markets. “Compared to what was going on in the U.S., it never got to the same level here, but having said that, they were going down the same slippery slope,” says Mr. Putnam.

 

“The Canadian population wanted to buy a home, that was the No. 1 goal.

 

“People were taking on high debt loads, stretching the amortization out as long as possible and lenders were looking at all the opportunities. It made sense when the market was hot, but of course, no one could foresee the problems.”

 

Exacerbating the situation, the early part of the decade saw the arrival of a number of U.S. players looking to get in on the Canadian market.

 

Because many of the players were not deposit-taking institutions, they qualified for looser regulations than banks and other traditional players.

 

That meant, for instance, that they didn’t need insurance for risky loans and they could lend in excess of the value of the property. Borrowers loved it at the time but in today’s post-crisis world, such loans are almost impossible to renew.

 

The good news for the Marentettes is that they succeeded in finding a new lender, though they’re still paying almost double the interest rate of a conventional mortgage.

 

Thousands of other subprime borrowers may not be so lucky.

 

“Hopefully, if they have been making their payments, they can qualify for [another mortgage],” says Jim Murphy, president of the Canadian Association of Accredited Mortgage Professionals.

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