[Globe and Mail – September 10, 2020]

Canada’s housing agency said there could be a “significant increase” in mortgage delinquencies later this year as banks’ loan deferrals during the COVID-19 pandemicend and alternative lenders deal with more troubled borrowers.

Mortgage Investment Corporations (MICs), which are alternative lenders that pool investor funds to provide loans, were already seeing a rise in delinquency rates before the pandemic struck in March, according to an annual report from the Canada Mortgage Housing Corp.

Then, in the early months of the outbreak, an estimated 10 per cent of borrowers from MICs requested a deferral, according to the CMHC’s Residential Mortgage Industry Report, the first government assessment of the alternative lending market during the economic crisis.

The CMHC said it did not know how many deferrals were granted by the MICs. But the proportion of alternative borrowers who were at least 30 days late on a payment had already reached 4.39 per cent at the end of last year, compared with 3.25 per cent mid-2019.

“There continues to be a risk that a significant increase in mortgage delinquency will be observed in the third or fourth quarter of this year as these deferral agreements come to an end,” the report said.

As of July 31, banks had provided mortgage deferrals of up to six months to more than 775,000 homeowners. That represents about 16 per cent of the banks’ residential mortgage portfolios, up from 10 per cent in April, according to their industry group, the Canadian Bankers Association.

“There is this potential deferral cliff,” said Tania Bourassa-Ochoa, a senior housing researcher with the CMHC.

The major banks have said they expect most of their borrowers to resume repayments when their deferrals expire, as many already have.

But with the economic recovery uncertain, the CMHC expects the delinquency rate to rise. “We do expect maybe a certain percentage will not be able to resume their payments,” Ms. Bourassa-Ochoa said.

The banks’ deferred mortgage repayments total an estimated $1-billion a month. That helped push up the country’s outstanding mortgage debt to $1.68-trillion in May, a 6-per-cent increase over the same month in 2019, when home sales had slowed because of stricter loan qualification rules.

MICs are the fastest growing segment of the mortgage market and have contributed to the higher outstanding debt. Since the Great Recession, MICs have expanded rapidly as it became harder for borrowers to qualify at banks. The MICs typically lend to riskier borrowers and at much higher rates.

From 2018 to last year, the MICs’ outstanding loans grew at a faster rate than overall residential mortgage debt.

The CMHC estimates that the MICs’ total market size was between $14-billion and $15-billion last year, compared with between $8-billion and $10-billion in 2016. As they have expanded, their loans have become riskier and more concentrated in Ontario and British Columbia, home to the country’s two priciest real estate markets.

Among the 25 largest MICs, the share of second and third mortgages in their portfolios increased to 22 per cent last year from 12 per cent in 2017. Those loans are considered more vulnerable than first mortgages because if a borrower defaults, the original loan will get paid before the second and third. At the same time, the MICs’ average loan-to-value ratio has increased incrementally, which means there is a greater chance of the property being worth less than loans if property prices decrease.

That increases the risk “that a property depreciation or a foreclosure will result in the debt not being entirely covered,” the report said.

The CMHC said the data suggest the risk profile of the MIC sector increased from 2018 to 2019, even before the pandemic and economic slowdown.

Since mid-March, some MICs have dealt with more homeowners who have lost income and cannot make their mortgage payments, and more investors who want to take their money out of funds. Some MICs have prevented their investors from withdrawing.

“MICs received a significant number of redemption requests from investors during the months of high financial uncertainty,” the CMHC report said. The agency relied on data from an outside research firm.

This is the CMHC’s fifth report on the residential mortgage market over the past two years.