The Standing Senate Committee on National Finance met this day at 2:19 p.m.
to continue its study of the Main Estimates for the fiscal year ending March 31,
Senator Percy Mockler (Chair) in the chair.
The Chair: Honourable senators, welcome to this meeting of the
Standing Senate Committee on National Finance.
My name is Percy Mockler, senator from New Brunswick, chair of the committee.
At this time, I would like to ask each senator to introduce themselves.
Senator Cools: I am Anne Cools from Toronto, Ontario. I am the deputy
chair, and I make it my business to attend all of these meetings, just as my
wonderful colleagues over here.
Senator Eaton: Welcome. Senator Nicky Eaton from Ontario.
Senator Marshall: Elizabeth Marshall, Newfoundland and Labrador.
Senator Galvez: Senator Galvez from Quebec. I'm replacing Senator
Pratte, who is also from Quebec.
Senator Oh: Senator Oh from Toronto, Ontario.
Senator Woo: Senator Woo from British Columbia.
Senator Forest: Éric Forest from the Gulf region of Quebec.
The Chair: Thank you very much, senators. Today, we continue our study
of the Main Estimates 2017-18.
Last week, in the wake of Moody's downgrading of the six major Canadian
banks, the committee met to assess the potential turbulence in the housing
market and the possible risk to the fiscal framework of Canada and, in turn,
We welcome as our first witness, from Moody's Investors Service, Mr. David
Beattie, Senior Vice President, Financial Institutions Group.
We want to take this opportunity to say thank you for accepting our
invitation to share your views and comments, to inform us on a subject matter
that all Canadians are chatting about, thinking about or discussing.
Later, we will hear from a representative of the International Monetary Fund.
I will ask you to make your presentation and share your comments with us.
Senators will be asking questions after your presentation.
The floor is yours.
David Beattie, Senior Vice President, Financial Institutions Group,
Moody's Investors Service: Thank you very much.
Good afternoon, Mr. Chair and members of the committee. I'm a senior
vice-president and credit analyst in the Financial Institutions Group at Moody's
Investors Service, based in Toronto.
I have been a lead analyst for the Canadian banks since I joined Moody's in
2011. On behalf of my colleagues, I would like to thank you for the opportunity
to participate in today's hearings and to speak to you about Moody's, our
methodology of rating banks and why we recently downgraded the ratings of six
Moody's is the oldest bond rating agency in the world, having introduced
ratings in 1909. Today, we are one of the world's most widely used sources for
credit ratings and research. Our role is to disseminate forward-looking opinions
about the relative credit worthiness of, among other things, financial
obligations of corporations, banks and governmental entities, as well as
asset-backed securities. Moody's ratings should be used as just one perspective
on an issuer's or debt obligation's credit worthiness. It is also important to
note that we are a credit market observer, not a direct participant.
Moody's forward-looking opinions address only one characteristic of
fixed-income securities: the likelihood that debt to be repaid in accordance
with the terms of the debt instrument. Our credit ratings reflect an assessment
of both the probability that a debt instrument will default and the amount of
loss the debt holder is likely to incur in the event of default. In assigning
our credit opinions, our analysts adhere to Moody's published credit-rating
methodologies, which we believe promote transparency and consistency in our
Our credit ratings are expressed according to a system of letters and numbers
on a scale that has 21 categories. The categories on the scale range from AAA to
C. The AAA level represents the lowest expected credit loss. The AA level
represents a relatively higher expected loss rate and so on down through the
Moody's rating system is not a pass/fail system; rather, it is a
probability-based system in which the forecasted probability and the magnitude
of credit losses rise as the rating level declines.
Regarding process, Moody's rating actions are determined by majority vote of
a committee comprised of experienced credit analysts with industry expertise and
Let me give you a brief overview on how we rate banks in particular. The
first stage of our analysis starts with our assessment of the operating
environment in which a bank does business. This includes consideration of six
key elements. We take three of those elements from our sovereign group's
analysis of a country's economic strength, institutional strength and
susceptibility to event risk. Then we overlay three banking adjustments, one
each for credit conditions, funding conditions and industry structure.
Next, we look at the specific bank's financial health, gauging key solvency
and liquidity ratios, and other metrics. We then assess qualitative factors,
such as the bank's level of diversification, its complexity and whether the
bank's strategy, management or corporate policies are likely to reduce or
increase its overall risk profile.
We also take into account the likelihood of support from bank affiliates and
an assessment of the relative exposure to various types of creditors in the
event of a bank's failure.
Finally, we assess the probability of government support in a failure
As you know, Moody's recently downgraded six Canadian banks and their
affiliates by one notch. Their senior debt and deposit ratings are now AA2 for
the Toronto Dominion Bank and A1 for Bank of Montreal, Bank of Nova Scotia,
Canadian Imperial Bank of Canada, National Bank of Canada and the Royal Bank of
Canada. These are still very high ratings in the context of our global rated
The action reflects our expectation of a more challenging operating
environment for banks in Canada for the remainder of 2017 and beyond. A key
driver of these actions was a change in our assessment of Canada's operating
environment for banks, which we called the macro profile, to "strong plus'' from
"very strong minus.'' This was driven by our view that credit conditions in
Canada have deteriorated. High levels of debt and rapid credit expansion can
signal credit quality problems that emerge later.
It's important to mention that the Canadian banks remain very highly rated
compared to global peers. This is due to their very strong asset quality and a
concentrated industry structure that gives individual banks excellent scale,
efficiency and earning stability. Canada's macro profile is also robust.
However, continued growth in Canadian consumer debt and elevated housing
prices leave consumers and Canadian banks more vulnerable to downside risks
facing the Canadian economy than in the past. A challenging operating
environment for these banks could lead to a deterioration in the bank's assets
quality and increase their sensitivity to external shocks. As part of our 2017
outlook on banks, we noted that Canada's elevated housing prices and related
high levels of household debt-to-income remain as vulnerabilities for the
While we do not expect macroeconomic conditions in Canada to improve in the
near term, the Canadian banks' ratings could be revised upward if that does
occur. Alternatively, the affected banks' ratings could be downgraded if their
fundamentals weaken as evidenced by an even more challenging operating
environment or a deterioration in their financial metrics.
Thank you again for inviting me to testify today. I look forward to your
The Chair: Thank you, Mr. Beattie. We will begin our questions.
Senator Marshall: Thank you very much, Mr. Beattie, for being here.
I'm particularly interested in the downgrading of the banks because the
statement that was put out by Moody's references asset qualities, the housing
sector. As you probably know, CMHC carries a significant amount of mortgage
insurance and leaves the federal government vulnerable should something happen
in the housing sector.
There are a couple of areas in the statement that I was wondering if you
could elaborate on. There is a reference to deterioration in the banks' asset
quality and increased sensitivity to external shocks. What external shocks would
qualify to be termed that?
Mr. Beattie: The external shocks could arise in many different places.
We don't always know what is going to be the trigger for problems in the
environment, whether it be trade policy, fiscal policy, other things that might
go on in other jurisdictions around the world that would affect the Canadian
economy. But we do believe that when a banking system has a high degree of
leverage, when a country has a high degree of leverage embedded within it, it
makes it less able to respond to shocks, and those could result in higher
interest rates, for example, or higher levels of unemployment.
Senator Marshall: Do you consider the fact that CMHC ensures a
substantial number of mortgages? Would that have been a factor?
Mr. Beattie: Very much so. Certainly that's a strength of the Canadian
banking system, that government-sponsored mortgage insurance is in place. When
we looked at the credit conditions in Canada, and it was a deterioration in the
credit conditions as we measure them that was the major factor in the reduction
in our macro profile, our measure of the operating environment, we take into
account the mitigating circumstances. There are some key structural features in
the Canadian mortgage market that are favourable for Canadian banks. CMHC is one
We also looked at the fact that there is a very low level of sub-prime
mortgages on the Canadian banks' books and the lower degree of securitization of
mortgages, which means that the banks that originate the mortgages tend to keep
them on their own books and service them over time. Those were all positive
factors that we took into account when we made this move.
Senator Marshall: There is also a statement that says all relevant
ratings for these banks continue to have negative outlooks, reflecting the
expected introduction of an operational resolution regime in Canada. What does
Mr. Beattie: In 2014 a public consultation paper was published on a
framework for a bail-in regime in Canada, an operational resolution regime. We
are still waiting for the details. But since we had a clear indication from a
policy perspective that this was coming, that will cause us to review our
government support assumptions that are currently embedded in the Canadian
banks' ratings. Each of the Canadian banks has in most cases two notches of
positive uplift in their ratings due to our expectation that the government
would support them in the case of the need for a resolution. Clearly, once we
get the rules for a bail-in regime, part of accepting that that is the policy of
the government going forward would be us being required to review our support
assumptions and possibly move them down.
Senator Marshall: That leads to my next question. Now that they have
been downgraded, what criteria would you be looking at to have them upgraded?
Mr. Beattie: If the credit conditions improve, if leverage within
Canada — we measure leverage. Our primary metric is private debt to GDP. That's
been deteriorating for a number of years in Canada. If that were to improve,
then that would cause us to potentially reassess our view on the macro profile
or the operating environment that the banks do business in, or if the individual
banks' financial metrics improved significantly, we would revisit.
We review our ratings on an ongoing basis, and any change in the performance
of the banks or operating environment we would want to embed in and reflect in
Senator Marshall: To go back to CMHC, they carry a significant portion
of the mortgage insurance. There are two private sector companies also
participating in that program, but you look at them and say that's a positive
for the banks because CMHC is there. Do you look at just CMHC or at the fiscal
position of the government, or do you say mortgage insurance is carried and
therefore you will leave it at that?
Mr. Beattie: We have a sovereign rating for the government of Canada,
and any obligations of the government with regard to CMHC would be factored into
that rating, which is at the highest rate possible.
We have a separate rating and analysis on CMHC. I'm not the lead analyst for
that, but we did publish a stress test on the Canadian mortgage industry last
year. I was a co-author on that report. We stressed both the banks and CMHC, and
the result under a severe stress scenario was that CMHC was adequately
capitalized to deal with severe stress without calling on the government for any
Senator Marshall: The government implemented additional requirements
last fall, such as stress testing. Would you have any information on whether
they are working or whether they are taken into consideration?
Mr. Beattie: We have written credit-positive research every time a new
macro prudential measure has been taken by the various levels of government to
try to tap the brakes on the accelerating housing prices in Canada. We view
those as positive developments. It's hard to analyze where we would be without
those things having been done, so we think they are laudable and we would be in
a worse position otherwise.
Senator Eaton: Mr. Beattie, educate me. When you downgraded the six
big banks, did you look at the six big banks as a lump, or is it because they
all needed downgrading? Is it more of an average?
Mr. Beattie: No, it's not an average. We would look at them
individually. In this case the rating driver primarily was this deterioration of
Senator Eaton: So they are all equally responsible for being
Mr. Beattie: That's one way of thinking about it.
I would say they are all significantly engaged in providing credit to
Canadian consumers. Their personal and commercial banking franchises here in
Canada are in each case their most important single businesses, so to the extent
that there is a problem in the operating environment that adds risk to Canadian
consumer and commercial debt, that factors and flows through. When we look at
the operating environment, that's our foundational piece of the analysis of each
individual bank. And because each of the banks is significantly exposed to
Canadian personal and commercial banking, we felt it was appropriate to take
There were two banks we did not downgrade in this action. We felt that they
had specific business profile characteristics such that they would be less
affected by a problem in the housing market.
Senator Eaton: Do you believe that actions taken by both the federal
government and — I don't know about Quebec, but I certainly know Ontario.
Premier Wynne took actions hoping to cool the Toronto housing market. Do you
believe that will have a beneficial effect? Will it work? In Vancouver, they did
the same thing.
Mr. Beattie: I think it is definitely having a beneficial effect.
Whether it will completely slow down or reverse housing price increases remains
to be seen.
Senator Eaton: But that does not affect all those people holding
mortgages that are putting the banks at risk?
Mr. Beattie: The way that would transmit through to the individual
mortgage holders would be if the home on which they've taken debt out suddenly
is much less valuable than it used to be, then that would cause them financial
Senator Eaton: We heard testimony last week from members of the
Finance Department. I think it was Senator Marshall and I who were tackling him
on the issue that if the Bank of Canada's rate goes up, that could send a shock
into the housing market. He felt that if the Bank of Canada rate went up that it
would be because the Canadian economy had become so strong that it would not
affect people carrying mortgages.
Mr. Beattie: I'm neither an economist nor a policy-maker, so what the
Bank of Canada does will obviously be undertaken in the context of their
responsibilities. I can say that in the past, rising rates in a highly leveraged
system tend to put more pressure on the borrowers.
The Chair: Honourable senators, I know that Mr. Beattie has a time
frame. We have approximately 10 minutes left. With that, I will call on Senator
Galvez, to be followed by Senator Oh.
Senator Galvez: I'm also not an economist but I want to learn.
Yesterday I heard the foreign minister from a South American country. We
talked about Moody's and other indicators of the health of banks — not only
housing and international debt, but other factors such as the financial sector,
the insurance sector, industry and foreign investment. I understand that Canada
is not doing well — these banks in particular — with respect to housing, but I'm
sure that there are positive aspects that play into the final rating.
In the case of Canada, could you please tell us how the other sectors are
influencing this final rate?
Mr. Beattie: As I described in my comments, the macro profile, which
is our measure of the health of the operating environment, has inputs from two
groups: our sovereign risk group, which is responsible for the rating of the
Government of Canada; and our banking area, which I'm responsible for. The areas
that you're speaking of that would be much more related to the economic health
of the government and of the economy as a whole would really be reflected by the
components that go into our macro profile that come from our sovereign group.
That's an area outside of my expertise.
What I do is look at the banking aspects of the operating environment, the
funding structure, the credit conditions and the structure of the industry
itself and overlay those.
I'm afraid your question is a bit outside my area of expertise. I can get
information on that from my sovereign colleagues, if that would be helpful.
Senator Galvez: Yes, I would appreciate that.
Senator Oh: Mr. Beattie, Canadian banks are always considered the most
conservative banks possible. During the 2008 financial crisis, we were probably
one of the most solid banking systems recognized by all the G7 countries.
Mr. Beattie: Yes, indeed.
Senator Oh: Canada was solid on the banking system.
When was the last time Moody's downgraded the six charter banks collectively
like this? And how do our charter banks compare to U.S. banks in today's
Mr. Beattie: We took an action not dissimilar to the ones we took in
January 2014. The two key drivers of that rating action were high consumer
debt-to-income and elevated housing prices. In a way, this is a continuation
along that same continuum in terms of deterioration and increased leverage in
the system over that period of time.
The Canadian banks were not downgraded during the financial crisis of
2007-08, but at that time, the operating environment in which they did business,
primarily here in Canada, was not as leveraged as it is today.
Senator Oh: How do the U.S. banks compare to Canadian banks today?
Mr. Beattie: We have a concept called the baseline credit assessment,
which is our foundational starting point for bank analysis. The Canadians banks'
baseline credit assessment when compared to the U.S. banking system would be
higher on average. The Canadian banks would be in the top 10 per cent of our
rated universe of banks around the world, globally.
Senator Cools: I'd like to welcome our witness today, Mr. Beattie.
I find myself a little puzzled by some of your statements and some of your
findings. That could mean nothing other than I am very inexperienced in the
business of banking, other than banking on a daily basis as most of us do.
In making the findings, you used some elegant language. You spoke about
credit worthiness and then you talked about the deterioration of credit
conditions. It's elegant language and obviously very specialized to your
business. But then you lose me.
You tell me you're making these decisions by a majority vote. Voting is never
a precise business. People vote quite often for emotional reasons. Could you
give me greater insight? Tell me what your instruments of measurement are.
Mr. Beattie: The key inputs to our bank ratings are as I described in
the piece. We start with the foundational assessment of the operating
environment; that is, has it gotten better or worse? Our view is even a very
strong bank in a poor operating environment is more likely to default on its
obligations than that same bank in a stronger operating environment. That's the
We then look at the solvency metrics that we use, which are asset quality,
capital and profitability. We add to that our assessment of the liquidity of the
banks, because often bank confidence is tied to liquidity considerations and the
ability to raise funding. We look at the liquidity and the reliance on wholesale
funding, which is more confidence sensitive than deposits.
Those are the key building blocks that we use to assess any given bank. We
try to be as transparent in our discussion of each individual bank and their
strengths and weaknesses on those measures.
We use metrics and compare those them globally, using the macro profile as a
way to equalize across countries.
We then add in qualitative issues, and perhaps some secondary quantitative
measures if the situation warrants, around diversification, governance issues
and corporate behaviour.
Finally, we take a look at any support available, either from affiliates or
As I mentioned earlier, historically we've always assumed that the Canadian
government, for reasons of financial stability, would support a troubled
institution. I think it's easy to understand that if the bail-in regime is put
in place, which clearly says taxpayers will not pay the bill if, in the future,
a Canadian bank gets into trouble, that will infer that the level of support in
Canada has been reduced — not necessarily eliminated, but reduced.
Senator Cools: You are speaking more about social sciences rather than
the hard mathematical sciences of measurement.
Mr. Beattie: No, we use strict, calibrated financial metrics. We have
"problem loans to total assets'' as a metric to gauge asset quality. We have
"total capital to total assets'' as a measure to gauge capital adequacy. We use
a number of metrics that have been back-tested and have been found to be
predictive of future problems.
Senator Cools: But your final decision is made by a vote.
Mr. Beattie: The final decision is made by a vote in committee,
correct. That's the way the firm works and I believe most rating agencies use a
Senator Cools: Okay. Thank you.
Senator Forest: Thank you very much for your presentation on such a
specialized topic; it is very much appreciated. You said one of the deciding
factors in your assessment is Canada's macro profile, which is influenced by
credit conditions in Canada, including consumer credit. Why have you downgraded
six major banks? The Fédération des caisses Desjardins du Québec, which is in a
similar environment as the other banks in Canada, was not downgraded. I
understand that the last rating dates back to 2014?
Mr. Beattie: I'm not the lead analyst for the Desjardins Group.
However, I can tell you that when we discussed it in committee, we had two major
reasons for excluding it from this action. The first one is that it's not
strictly a banking organization. It derives a large proportion of its earnings
from personal and commercial property and casualty insurance and life insurance,
and we didn't feel that those were lines of business that would be impacted by
the concerns we had about the credit conditions in Canada.
We also looked at its exposure to the housing markets with the highest amount
of house price increases, those being the Greater Toronto Area and the Greater
Vancouver area, and the Desjardins Group, through its caisses, is almost
exclusively involved in Quebec. So it was less likely to have exposure to the
housing risks that we were most concerned about in our action.
I'm sorry, was there a second part to the question?
Senator Forest: That explains the more specific features of the
Desjardins group. My last question is as follows. Did I understand correctly
that the last time that Canadian banks were downgraded was in 2014?
Mr. Beattie: Yes. In 2014, I was involved in that action as well and
it was frankly prompted by similar concerns around elevated housing prices and
the high consumer debt-to-income. Our methodology was not as explicit in the
measurements that we now use for the operating environment, but there was a very
strong sense that there was a growing level of leverage in the system as a whole
that put downward pressure that we felt needed to be reflected in the ratings at
It's a continuum. It's not something that's a step function and you reach
this point and you make a move. Judgment is involved in deciding when another
rating action is required.
Senator Forest: In short, looking at the broader picture, it is clear
that when we compare ourselves, being downgraded is never a good thing. From
what you have said, compared to the international banking system as a whole, our
banking institutions are still doing very well.
Mr. Beattie: Yes, that's absolutely the case. These are amongst the
highest-rated banks globally by Moody's. We feel they are very prudently managed
institutions that have performed extremely well and consistently over time. It's
a small decrement in their standing, but they remain very highly rated banks.
The Chair: I have a few questions, Mr. Beattie, reflective of banks'
assets. Are there certain types of assets at greater risk than others?
And what tools do the banks have to protect themselves from what we call the
Mr. Beattie: On the first part of your question around what would be
the more concerning classes of assets, quite frankly, even though the bulk of
consumer debt is tied up in mortgage debt — somewhere around 60 per cent of
total consumer debt would be related to housing — that's not where we expect to
see large incremental losses if there were to be a stress event. It would be the
less well-secured asset classes: the credit card balances, the indirect auto —
even though it is collateralized by a vehicle, it's not as good collateral as a
home — and unsecured lines of credit. Those would be the asset classes where we
expect to see much larger losses given default. Once a default happens in a
mortgage, you still have the collateral to offset the loss. When there is a
default on a credit card, it's usually a 100 per cent write-off.
The Chair: When we look at housing, and we saw what happened south of
our border in 2008, how do you rate the housing aspect in Canada in terms of
influencing that downgrade?
Mr. Beattie: Our view of the housing risk in Canada as a contributor
towards private debt-to-GDP, which was our primary metric in the credit
conditions, is that it's obviously an important contributor to that concern. But
the Canadian housing market, as I mentioned earlier, has several very favourable
structural features that protect the banks from losses in housing, which include
the CMHC, the low levels of sub-prime, the low levels of origination for
distribution type activity that we feel, in comparison to the conditions in
place in the U.S. prior to the housing crash, are positive influences.
The Chair: Mr. Beattie, as we conclude this first element of our study
on the estimates, I am informed that the Senate Finance Committee has received
Moody's, so I want to thank you very much for accepting our request to be here
Mr. Beattie: Absolutely. Thank you for having me.
The Chair: If there is any follow-up, we will write to you through the
clerk to bring that to your attention.
Senator Forest, do you have another question?
Senator Forest: Simply a comment. I hope Moody's will not make a habit
of downgrading our banks to get an invitation here in the future.
The Chair: Thank you, Senator Forest; I thought you had a question.
Mr. Beattie, thank you very much.
Honourable senators, for our second panel we have the distinction of having
with us Ms. Cheng Hoon Lim, Assistant Director for the Western Hemisphere
Department of the International Monetary Fund.
Thank you very much for accepting our invitation. I'll ask you to make your
presentation, to be followed by questions from senators.
Ms. Lim, please go ahead.
Cheng Hoon Lim, Assistant Director for the Western Hemisphere Department,
International Monetary Fund: Thank you, Mr. Chair, and members of the
committee for inviting us to be here this afternoon.
For those of you who may be unfamiliar with the IMF, the International
Monetary Fund, let me give you a bit of background information.
We are a cooperative institution of 189 member countries. Our core
responsibility is to oversee the international monetary system and to monitor
the economic and financial policies of its member countries.
As part of this surveillance process, which takes place at the global,
regional and country levels, the IMF identifies potential risks to stability,
and we recommend appropriate policy adjustments needed to sustain economic
growth and to promote economic and financial stability.
As it happens, we are currently engaged with the Canadian authorities on this
annual consultation process, and not surprisingly, the housing market has come
up as an important issue for the economy.
In fact, it is hard to avoid reading about the housing market. It is in the
news almost on a daily basis, and I think that's probably because of the
problems at Home Capital, even though it is not a systemic case and the event
was isolated. The ratings downgrade by Moody's has sparked broader concerns
about the health of the housing market.
Now, what are these concerns? What is driving these concerns? There are three
that are often cited.
First is the fact that Canada's largest banks have a sizeable exposure to the
housing sector. The big six banks account for about 93 per cent of total banking
system assets. They allocate about a third — 35 per cent — of their total assets
to consumer and mortgage lending and draw 50 per cent of their total revenues
from these loans. Mortgage lending alone accounts for 45 per cent of the banks'
The second factor that's commonly cited is the fact that Canadian households
have a very high level of debt. You heard earlier from Mr. Beattie that
household debt to disposable income was an issue for the institution for
Moody's, in terms of their downgrade: The household debt to disposable income
ratio has reached 170 per cent. This is among the highest in G7 economies.
The third factor is the rapid acceleration of house prices that we have seen
in the past two years in Vancouver and in the past few months in Toronto, and
they have occurred at a rate that is difficult to justify by fundamentals.
According to a survey on affordability, Vancouver house prices rose the
equivalent of a full year's household income in one year.
Now, these concerns are valid, but what I would like to emphasize today is
that we should keep them in perspective. The housing market is overheated, but
the hot spots are mainly concentrated in Vancouver and Toronto. The high level
of debt is a vulnerability for the financial system given the banks' exposure,
but there are safeguards in place to ensure the resilience of the banking
OSFI exercises very strict supervision. It continually updates its
expectations of underwriting standards by banks. These are the B-20 guideline
that it issues to banks on all their mortgage underwriting.
The banking system has adequate capital and liquidity buffers. Mortgages in
Canada are full-recourse loans except in two provinces.
Finally, a significant portion of mortgages in Canada are backed by the full
faith of the government.
In addition, the authorities have been proactively responding to developments
in the housing market. They have introduced prudential and tax-based measures to
reduce housing imbalances and to mitigate risk.
We welcome these measures and we see they are beginning to show some evidence
of working to reduce housing imbalances, but given the facts that household debt
is so high and that the banking exposure is significant, we would recommend
further strengthening the resilience of the household and banking sector. In
this regard we have three recommendations.
The first is the further tightening of prudential and tax-based measures to
mitigate speculative and investment activity. Among these measures we would
encourage the authorities to consider putting a cap on household debt to income.
This would be the amount of debt that a borrower can borrow from a bank, to
limit it to a certain threshold of the income that the borrower earns.
In general, however, we would recommend that these measures not discriminate
between residents and non- residents. Thus far we do not see evidence to suggest
that non-resident activity is the main driver of rising house prices.
The second recommendation is for greater coordination between federal and
provincial regulators to strengthen surveillance and to resolve emerging
problems in a timely fashion.
And our third recommendation is to provide dedicated resources — and I know
that the federal government now has allocated funds in the budget to do this —
to collect more comprehensive data in real estate transactions. This is
important to better understand the underlying dynamics — how they change; who
buys and who sells — and to improve the effectiveness of the authorities' policy
response and prevent circumvention.
I will stop there and I'm happy to take your questions.
Senator Marshall: Thank you very much for being here today. I did read
your 2016 report called Article IV Consultation. It's a multi-page
document. I was interested in the area where you talking about Canada and the
risk- assessment matrix. Was there a risk assessment? What was the result of the
risk-assessment matrix for Canada?
Ms. Lim: The risk-assessment matrix is a framework for us to think
about what possible shocks could affect the Canadian economy. In the report in
front of you, one of the risks we looked at a sharp house price correction.
As I said earlier, there is a strong linkage between the housing sector and
the banking system. If, for some reason, there is a shock to the system, such as
unemployment going up, which affects the ability of households to earn income,
this would affect their ability to service that debt and as a result it would
have implications on banks' portfolios. It is a way for us to think through the
channels by which a negative shock could affect the Canadian economy.
Senator Marshall: What kind of rating did Canada get last year? You're
probably working on your 2017 report. This shows a category of high, then
medium-high, another medium-high and a medium. Where would Canada have fallen?
Ms. Lim: In terms of the housing sector, the impact is high in the
sense that if there is a shock to the housing sector the economy will know it;
the economy will feel it.
When we assess, just as Moody's does, when you think about a shock there are
two ways to think about it: One is the probability of the event happening and
the other is the impact. On the impact, we see a high impact because the housing
sector is an important component of the Canadian economy.
In terms of probability of it happening, we see a lower probability. I think
in last year's report it was low to medium.
Senator Marshall: When I look at that assessment, I think this is
probably something that buffered the conclusion in that it says the impact on
the banking system would be severe but mitigated by mortgage insurance, CMHC and
private insurers' own loss-absorbing capacity.
Could you talk about mortgage insurance, CMHC's role and how that links up to
the federal government in Canada? That's one of the areas that I'm concerned
about. CMHC is a Crown corporation, so what happens at CMHC will have a direct
impact on the Government of Canada's operating results and fiscal position.
You're looking at CMHC and saying they are going to be there and they carry
quite a bit of mortgage insurance, so that's a buffer. Could you talk about
Ms. Lim: You're right. What happens at CMHC will impact the
government's balance sheet, but I would note that CMHC increased its capital
buffer by raising the mortgage premium. I think this was a year ago. It had a
sort of a ladder structure so that loans with the highest LTD, meaning loans
that are the highest risk, have a higher increase in the mortgage premium.
I think that CMHC is prudent in its actions. It's ensuring that it has
sufficient capital to be able to withstand a shock to the housing sector that
would entail a contingent liability on their balance sheet.
Senator Marshall: When you talk about a shock, give us an example of
what could happen that would be considered a shock.
Ms. Lim: For example, there is a shift to trade protectionism and
economic fragmentation, and that shift in policies around the advanced economies
causes a decline in global trade.
Canada, as we know, is an economy that is open in the sense that it is highly
reliant on cross-border flows on trade. If there is a shock to global trade and
that leads to a decline in other countries' demand for Canada's goods, that
would mean fewer jobs for Canadians. Unemployment would go up, and that would be
Senator Marshall: What about interest rates? Right now interest rates
are very low. We've seen a lot of articles in the media lately about surveys
saying that many consumers are on the brink, that they can barely manage their
household expenses now. And we're seeing articles saying that interest rates
should go up. Would that be another example of a shock to the system?
Ms. Lim: Yes, that would be another example of a shock to the system.
I would note that the authorities, I think in October last year, have made
the qualification criteria more stringent. In other words, if you want to take
out an insured mortgage, you will need to qualify now not just at the posted
interest rate, but at the posted rate plus another 2 percentage points. This is
to suggest that the households that take on these mortgages would be more
resilient to an increase in interest rates, at least up to the additional 2
percentage point stress test.
Senator Marshall: I don't know if this question falls within your area
of expertise, but I keep seeing articles that talk about how the housing sector
is such a big part of our gross domestic product. I think you were saying
earlier that you have 189 member countries, and I thought you said we're the
highest in the G7 countries regarding private sector debt to GDP.
What normal percentage of GDP should the housing sector represent? Is that a
question you can answer?
Ms. Lim: That's a very good question and a very difficult one to
answer. There are different thresholds, but clearly when private debt to GDP
exceeds 100 per cent of income, we would want to pay attention to that.
Senator Marshall: Thank you very much.
Senator Eaton: You were talking about shocks to the system. I was
thinking about softwood lumber being a shock to many provinces: Quebec, British
Columbia, New Brunswick. So we have that shock going on right now.
We have a debt that is forecast to be about $125 billion over the next five
You raised the issue in one of your letters of 2016 about oil recovery. Well,
the price of oil hasn't been that firm. Now, to add to everything else, we have
the NDP and Green alliance in British Columbia, which will perhaps delay if not
cancel the Kinder Morgan pipeline altogether, unless the federal government
comes down hard.
Do you see all those things coming together to drag us down, or do you feel
reasonably optimistic about the future, the next year or so?
Ms. Lim: We don't really comment on specific transactions or specific
Senator Eaton: But if you look at the overall picture, if you look at
oil prices not climbing, a pipeline in doubt, debt?
Ms. Lim: Obviously a high oil price is good for the Canadian economy,
but going forward, one thing I think we need to keep in mind is that the 2014
oil shock actually prompted many of the oilsands companies to rationalize their
operations, which means they cut costs. They are actually able to operate at a
much lower oil price today than they could two years ago.
Even though oil prices are probably going to be range-bound between 45 to 55,
we don't see that as impacting oil firms in the way that it did in 2014.
Senator Oh: Thank you for your information.
Canadian housing prices, compared to any other part of the world, are
probably still the lowest. It is one of the best countries to live in the world.
I travel around. Our house prices are the lowest compared to Asia and Europe.
Your concern is that household debt is so high, but Canada is so big. The
only two cities that are affected are Toronto and Vancouver. In the rest of the
country, house prices still probably remain the same or are only up maybe 10 per
cent to 15 per cent.
I have been here for 40 years. I have seen house price corrections probably
three times — they go up and come down — and the highest interest rate for
mortgages was in 1984 at 23 per cent.
How does this justify the alarm when there only two cities in this big
country where the prices are higher than in other cities?
Ms. Lim: I would agree with you. I think I said at the outset that
there are concerns about the housing sector, but they should be kept in
perspective because a lot of the price appreciation we have seen has been mainly
concentrated in those two cities. In Alberta, for instance, we actually see
house prices declining.
I think what the Bank of Canada would say, the trifurcation of the housing
market, there is no single housing market in Canada. In fact, there are three
housing markets in Canada. The policy response needs to take into account that
there are these regional differences.
But I agree with you that we should keep it in perspective.
Senator Neufeld: The B.C. government three months ago or so put
another tax on foreign investment in the housing industry. I think Ontario is
now starting to follow along.
In your estimation, did that help or was it for naught?
Ms. Lim: Even before the 15 per cent tax — I think that's what you are
referring to — on non-resident buyers in Vancouver, prices in Vancouver at that
time had already started declining. When the tax was introduced, we did see an
acceleration in terms of the decline in house prices and also in terms of the
Now the question is: Is this going to continue or is this largely a temporary
effect? I think the latest data that we have seen, for April, shows that house
prices are beginning to go up again. I do think that those measures had an
expectational effect on home buyers, but I'm not sure that they really changed
the fundamentals of what is going on.
Senator Neufeld: I think you said also that the house prices in
Vancouver were not driven by international investment but by local investment.
Did I understand you correctly? I don't know; I don't read all the work that you
do. That certainly isn't what has been said for a long time in Vancouver. It's
because many houses are purchased and not even lived in, or the kids might live
in them for a couple of years and go to school in British Columbia and then go
back home. I live in British Columbia, so I hear that quite often. I'm just
wondering. What you said is totally different than what I believe.
Ms. Lim: What we look at is data, and it's one of the reasons why we
recommend that the authorities collect data on real estate transactions. We have
seen little evidence to suggest that non-resident buyers are the main driver of
the increase in house prices.
In Vancouver, there was survey data to suggest that non-resident buyers
comprised 13 per cent of total housing transactions before the tax was
introduced, and it fell to about 3 per cent to 4 per cent after the tax was
introduced. It did, as I say, have an effect, but is 13 per cent significant?
I think it's important to keep in mind that the tax-based measures could be
broader. It could be based on the activity and not necessarily on the residency.
So if local authorities are worried about speculative activity driving up house
prices, then the tax should be based on the activity.
Senator Neufeld: I would suggest that there were a lot of people
selling their homes who had probably lived in Vancouver for 30 or 40 years and
all of a sudden saw their house worth 10 times what it was when they bought it.
They moved to another part of British Columbia and bought a house that was
cheaper. I think that's a lot of what took place. They moved out to the suburbs.
Would you agree with me?
Ms. Lim: I think your anecdotal evidence is probably right. I think
that there were people cashing in on a rising market. There is nothing wrong
with that. What we want to avoid is excessive speculation that drives up the
prices so high that it's difficult to sustain them when you look at income
Senator Neufeld: As a comment, having a high oil price, as far as I'm
concerned, is good for Canada, but in parts of Canada it certainly was not
viewed that way, let me tell you. In Eastern Canada it was not viewed that
having high oil prices was good for the economy. It all depends, I guess, where
Senator Galvez: You talked about shocks to the market and also about
risk. In my understanding, risk is the probability of something happening
multiplied by the impact or the severity of the event.
We are observing that climate change is coming here to Canada in the form of
flooding, water rising, and the two particular areas that we are discussing here
are places near the Great Lakes and places near the ocean in Vancouver.
The houses there are very expensive, and that's also the reason because they
weigh so much in the market and in the balance of the finances.
If some major thing happens and affects vast areas of these particular
cities, how will the market and the banks react?
Ms. Lim: Hopefully such a catastrophic event does not occur.
I think one can view the housing market as one would view a normal economic
situation in the sense that it all depends on demand and supply. If something
like that were to happen and affected the desire to buy houses in those areas,
then, yes, obviously it would have a dampening effect on house prices. But this
is a more hypothetical scenario, I would say.
Senator Galvez: It happened this year in this area; 3,000 households
were evacuated. Many people lost many things in their houses, so it's not that
hypothetical. It's happening.
Senator Woo will tell you that it has happened in Singapore, too. It is
becoming less and less hypothetical.
Ms. Lim: I take your point. Yes, thank you.
Senator Forest: Thank you very much. That is very interesting. The two
main overheated real estate markets in recent months have been Vancouver and
Toronto. This is a specific situation, and not necessarily structural. In light
of that, in comparison to the other G7 countries, what is the greatest threat to
the strength of the Canadian economy?
Ms. Lim: I think I alluded to this earlier. I think that what happens
in global trade will be important for Canada, and a large part of that will also
depend on the policy outcomes of the U.S. administration.
Another possible source of risk could be oil prices. We could see a further
decline in oil prices.
Around the world, too, we see economies recovering. We see global
manufacturing recovering, but it has been a slow process since the crisis in
2008. There have been concerns that we are in a period of low growth for a long
period of time. If this continues, it would be another dampening effect on
Canada because Canada will not be able to export as much if external demand is
Those are some of the external risks that could impact Canada.
Senator Marshall: I wanted to follow up on something. When I was
speaking with you earlier, I mentioned that we were using the 2016 Article 4
consultation. When will the 2017 report be released?
Ms. Lim: It will probably be in the early part of July.
Senator Marshall: Thank you.
Senator Anne C. Cools (Deputy Chair) in the chair.
The Deputy Chair: I'd like to thank the witness very much. We have
appreciated hearing her data and her sound mind at work.
Honourable senators, we now have before us two officials from CMHC. Forgive
me if I fumble the pronunciation. We have Wojo Zielonka, Chief Financial Officer
and Senior Vice President, Capital Markets; and Romy Bowers, Chief Risk Officer.
I'd like to know how you manage the risk.
In any event, the floor is yours. Perhaps you could choose how you want to
Wojo Zielonka, Chief Financial Officer and Senior Vice President, Capital
Markets, Canada Mortgage and Housing Corporation: I have some opening
It is a pleasure to be here today with my colleague Romy Bowers, CMHC's chief
risk management officer. I appreciate the opportunity to make some opening
As Canada's authority on housing, CMHC has the mandate to contribute to the
stability of housing markets and Canada's financial system. We do this in a
number of ways, through our mortgage loan insurance and securitization
activities, which are cornerstones of Canada's housing finance system; by
continuously monitoring housing markets for emerging trends and signs of
trouble; and by advising the Government of Canada on matters related to housing
and housing finance.
As the committee knows, mortgage loan insurance facilitates access to housing
finance for qualified Canadian homebuyers, supporting the stability of our
financial system and economic growth. CMHC's securitization programs facilitate
access to funds for residential mortgage lending.
Importantly, our mortgage loan insurance and securitization guarantee
programs operate on a commercial basis without the need for funding from the
government. In fact, earlier this morning we announced that we have implemented
a dividend framework and will consider paying a quarterly dividend to the
government in the event that our actual capital exceeds our capital target.
As part of our first quarter financial report, on the continued strength of
our performance, CMHC will pay a dividend of $145 million to our shareholder,
the Government of Canada. We also expect to declare a special dividend during
Nevertheless, the government's backing of our mortgage loan insurance and
securitization activities represents a significant exposure to the government.
We take this risk very seriously.
As a Crown corporation with a mandate to contribute to financial stability,
we believe CMHC must be a leader in housing risk management. This is job one at
CMHC. Risk management is linked to everything we do.
Following a review of CMHC by the government and the Office of the
Superintendent of Financial Institutions, CMHC has significantly strengthened
our risk management policies and practices over the past number of years,
including in the areas of internal audit and lender quality assurance, stress
testing, capital management and model governance. This work is ongoing. Last
year, for example, we revised our risk appetite framework to use a conditional
model that navigates between different states.
To summarize, we will prioritize financial stability unless and until
economic dislocation occurs. In those events, we stand ready to take a more
active role in supporting Canadians' access to housing. This reflects one of the
strengths of Canada's housing finance system. CMHC is available as a policy tool
through all economic cycles.
We are also working with our colleagues at the Department of Finance, the
Bank of Canada and OSFI to explore ways to distribute risks more effectively
across the financial system while maintaining government support for housing
As the Government of Canada's policy adviser on housing, CMHC has contributed
to the development of successive measures by government to stabilize housing
markets. These include the important changes to mortgage loan insurance programs
announced by the Minister of Finance last October.
In our judgment, the mortgage insurance regime was providing undesirable
stimulus in the marketplace. We sought to remove distortion, not to add any. We
believe these measures were necessary to help protect new homeowners' financial
security as well as the economic stability of Canada.
Action was also needed to address the level of household indebtedness in
Canada, which is now at an historic high of 167 per cent of disposable income.
The Bank of Canada calls this factor the greatest vulnerability to our economy.
Recent developments, including Home Capital and the downgrading of Canada's
big six banks by Moody's Investors Service, has caused some to question the
stability of Canada's housing finance system. Moody's is a respected credit
rating agency and its opinion matters to market participants. Notably, Moody's
has cited high levels of household debt and elevated house prices as key reasons
for the downgrading, which is what you heard earlier on today. This is
consistent with CMHC's analysis of market conditions.
Having said that, CMHC is not concerned about the state of our financial
exposure and we remain confident in Canada's housing finance system in general.
Canada's banks have consistently been rated among the strongest in the world.
Moreover, CMHC's latest stress testing results demonstrate that the corporation
has sufficient capital to withstand severely disruptive economic conditions.
This is not the first time Canada's big six banks have been downgraded, but
it does provide a note of caution that we need to remain vigilant against risks
that could jeopardize the stability of Canada's financial system.
Thank you again for the opportunity to be here. We would be pleased to answer
any questions the committee may have at this time.
The Deputy Chair: Thank you.
Ms. Bowers, do you want to say a few words?
Romy Bowers, Chief Risk Officer, Canada Mortgage and Housing Corporation:
Yes. Thank you very much for your invitation.
To add to my colleague's comments, I wanted to say a few words about our
stress testing program at the CMHC.
Stress testing is a risk management technique to understand how key risk
drivers impact a company's balance sheet and financial position, as stress tests
are meant to test an institution's resilience to exceptional but plausible
events. Stress testing is used by banks and insurance companies to test the
adequacy of their capital position.
In recent years, given our status as a Crown corporation, CMHC, as you
probably have noticed, has been publishing the results of our stress testing
activities. We've done this because we are a Crown corporation and want to
create greater transparency of our risk management activities.
We do our stress testing on an annual basis in conjunction with our corporate
planning process. Stress testing is a valuable tool for management because it
helps us understand the operational resilience of our organization and determine
adequate levels of capital buffers we need to maintain our balance sheet.
Given the nature of our business, the mortgage loan insurance business
specifically, the key drivers of loss for us are high unemployment coupled with
a dramatic decrease in housing prices.
Over the past few years, we have developed a suite of different macroeconomic
scenarios. To give you a few examples, we have done scenarios related to a drop
in oil prices, an earthquake in Vancouver, as well as a global deflation
There is one scenario that is particularly important for us, and we call it
the 5-30 scenario. It's basically a simulation of the 2007-08 U.S. downturn in
the Canadian context. The reason why that scenario is important to us is as
senior management we believe that we need to maintain enough capital on our
balance sheet to withstand a shock of that nature.
Under the scenario, our losses increase quite dramatically. When you look at
the five-year plan, they increase eightfold to what we would experience under
benign economic conditions. Our capital ratios, which are very strong at the
outset, decline to very close to the minimum levels required by OSFI, which is
We feel that, as I mentioned, we need to maintain enough capital to withstand
this level of shock, and we make sure we run the scenario on an annual basis as
we determine our dividend policy, something that Wojo referred to a few minutes
It has been mentioned in other committee discussions that CMHC is under OSFI
supervision. OSFI looks at all our risk management practices, and stress testing
is no exception. OSFI publishes requirements that financial institutions are
expected to comply with in respect of their stress testing programs, and we
comply with these.
Since CMHC came under OSFI's supervision in 2012, we have made significant
efforts to advance our risk management capabilities and invest in our stress
testing capabilities. We continuously benchmark our risk management practices,
and with respect to stress testing, we have a continuous improvement mindset in
terms of strengthening our capabilities in this area.
To give you some context, over the last three years, approximately 50 risk
management staff have been added to CMHC's staff complement, and many of these
staff are involved in our stress testing work.
In accordance with OSFI's expectations, we have very strong controls and
governance around our stress testing activities. The highest level of oversight
is provided by our board of directors, but there are other additional controls
and oversight provided by senior management committees, by internal audit,
finance and people in risk management.
I just wanted to provide a little colour around stress test activities. We
would be pleased to answer your questions.
The Deputy Chair: Thank you very much.
Just to be clear, I thought I heard you say that you only came under the
supervision of the Office of the Superintendent of Financial Institutions in
2012. It's that recent? What happened before?
Mr. Zielonka: That was a decision that was made. In 2012 OSFI started
providing oversight of our activities. We're not formally regulated, but for all
intents and purposes we follow all OSFI guidelines and they're on site every
Before that, the process was that we have a board of directors and we have
audits. The Auditor General does special exams. They are also one of our joint
auditors, so the oversight happened through those processes rather than having
the additional oversight of OSFI.
The Deputy Chair: That's interesting. Thank you very much.
Senator Eaton: In your remarks, Mr. Zielonka, you said that Moody's is
a respected credit agency but this is no big deal that it lowered the boom on
the six major banks in Canada. However, it didn't do that in 2008. Why do you
think it did it now? Is it just because of the housing? Weren't we just as
exposed in 2008 to other shocks? You don't seem to be perturbed that it did it
Mr. Zielonka: Just to be clear, I think Moody's is assessing the
Canadian banks and is in a better position to speak on their behalf. They're
assessing the Canadian banks in the context of other banks globally.
Senator Eaton: I've heard them, but I was surprised at your tone of,
well, it doesn't make any difference that they've downgraded the banks. You're
not particularly bothered by the fact that they downgraded the banks.
Mr. Zielonka: Well, Canadian banks remain very highly rated. Even
though they've been downgraded, we should recall that Canadian banks are some of
the highest-rated banks in the world, which continues to be the case.
Senator Eaton: It's still a downgrade.
Mr. Zielonka: It's still a downgrade; that's absolutely correct.
Senator Eaton: Something the IMF said in one of their reports is they
feel the oversight of housing in Canada is spread between the Department of
Finance, the Superintendent of Financial Institutions, you and the provincial
governments. Would it be helpful if it were more centralized, for instance, if
you had the whole pie rather than have so many oars involved in every decision?
Mr. Zielonka: That's not a decision that we make. Consultations happen
on a regular basis. The Department of Finance has a committee called the senior
advisory committee that advises the —
Senator Eaton: But it's not a formalized structure.
Mr. Zielonka: It's not a formalized structure, but it is a committee
that meets on a regular basis on which we participate on matters related to
housing. So there is a lot of coordination that happens. We consult with our
colleagues at the various agencies on a regular basis. There is a high level of
coordination that goes on today.
Senator Eaton: How about the provinces?
Mr. Zielonka: In our role in securitization, in particular, where we
deal with financial institutions that are provincially regulated, we also
consult with regulators from time to time. There is some coordination that goes
on in terms of institutions that are provincially regulated.
In terms of the broader housing market files, I think those interactions
happen at a number of different levels. The Department of Finance, I would
presume, would also have contacts with them. There are a number of different
Senator Eaton: So you don't believe it should be more centralized?
Mr. Zielonka: It's not for me to really speculate on what would be the
ideal or not because it is not something —
Senator Eaton: I'm asking for your opinion.
Mr. Zielonka: There are advantages to both. It's not a reality we're
confronted with, so I find it a bit difficult to —
Senator Eaton: On this committee, sometimes we try and improve things.
We try to find ways to put in our reports another way of doing something or
looking at something, and if nobody will tell us really what they think, nothing
ever gets changed.
Senator Marshall: Welcome back.
Where's the biggest risk for CMHC? Is it in the mortgage insurance area?
Mr. Zielonka: As my colleague Romy outlined, the scenario for us that
creates a potential negative outcome is really if you've got a rise in the
unemployment rate coupled with house price decrease.
House price decrease in itself is not necessarily a bad scenario. Just
because their house value has gone down, people don't walk away from their
mortgages. It really only becomes a problem if someone loses their job and they
can't sell their house for what they bought it for in order to cover their
mortgage. That's where it becomes a poor outcome.
Unemployment, ultimately, is the danger that we would be concerned about.
There are always fluctuations in the unemployment rate.
Senator Marshall: Would that roll into mortgage insurance? I'm just
trying to get a handle on it.
Mr. Zielonka: Initially it would roll into mortgage insurance. That's
where they would experience the losses.
We also have a securitization activity, which is a little bit different,
because we're only exposed when — there has to be a series of events, including
a significant failure of financial institutions. It's when homeowners or
mortgage insurers stop paying for whatever reason, and then financial
institutions essentially being no longer there. In that case, securitization
would have to step up.
Those are extreme events that we don't foresee at this point in time.
Senator Marshall: Right. But if some risks did come to fruition — I'm
just trying to get a handle on your link to the Department of Finance. We went
down this road last time you were here, and I still don't have it straightened
out. I'm going to have another go at it.
The last time you testified at this committee, you said that you have the
wherewithal financially to look after your own for a while. How extensive would
the problems have to be before you'd have to go to the Department of Finance and
say, "We need some financial help''? How much can you bear as a corporation?
Mr. Zielonka: Before we would actually have to ask for funding, the
events would to have cataclysmic.
Senator Marshall: Catastrophic.
Mr. Zielonka: Catastrophic to the power of two kinds of things. We
have a large investment portfolio.
There are two answers to that. There is an answer in terms of when our
capital falls below the capital levels for private mortgage insurers. That would
be a scenario of a 5 per cent increase in the unemployment rate and a 30 per
cent drop in housing prices across the country.
Senator Marshall: Do you have a dollar amount?
Mr. Zielonka: We do, actually.
Ms. Bowers: In that case, we would incur, over the five-year plan,
about $10 million in losses.
Senator Marshall: And your mortgage insurance is what, $500 billion?
Ms. Bowers: That's right.
Senator Marshall: Tell us a little bit about the dividend you
mentioned in your opening remarks, because that's of interest to me. Who decided
on the $145 million? Is that something you negotiate with the government? Is it
the sole decision of the board of directors, or is that dictated by the
Department of Finance? How do you come up with the $145 million?
Mr. Zielonka: Let me outline a little bit.
The government has, in the last few months, provided guidance in terms of
what they would like Crown corporations to do. Essentially, the guidance is if
you've got excess capital, to return it. There is actually a capital and
dividend framework that we have operationalized.
There are two things that we've done. We're looking at what we have in terms
of surplus capital, and we have a significant amount of surplus capital overall
that is sitting there. We're looking at paying a special dividend to the
government as part of that. That's one piece of it.
But then we actually make a lot of net income on a quarterly basis, so we've
instituted a dividend policy, which just got approved a few weeks ago by our
board of directors. It's in keeping with the government directions for the
framework. That dividend policy leaves a lot of discretion to the board, but
ultimately, it says that if you have surplus capital and you don't need it, pay
Senator Marshall: Return it.
Mr. Zielonka: Return it.
As part of that, the intent would be to pay out on a quarterly basis a
portion of our net income. Then, at the end of the year, any surplus net income
we don't need, we would pay out at that point in time.
Senator Marshall: Would that government framework be in writing?
Mr. Zielonka: I believe it is. It's something that's been shared with
the financial Crown, in particular.
Senator Marshall: So why is it a dividend? There are monies owing or
an investment account, isn't there, by the government? Why is it as a dividend
and not repayment of a loan or repayment of advances?
The Department of Finance, government and CMHC are linked together like that.
When you look through the Public Accounts, you see money relating to CMHC almost
everywhere. So why a dividend and not a repayment of a loan or an advance?
Mr. Zielonka: Regarding CMHC's capital structure, we have $25 million
of contributed capital, which was used to set up the corporation historically.
I'm not sure if that goes back to 1946 when the corporation was set up, but
that's what we have set up. It's called contributed surplus. All our earnings
over time have accumulated, so our retained earnings are a very large amount.
We have debt, some of which is historically related to loans that we made on
behalf of the government through various programs the government had over time.
Paying back that debt wouldn't actually impact our capital level. The only way
of actually reducing our capital level, reducing that surplus, is either a
dividend or a return of contributed surplus. Because we only have $25 million of
contributed surplus, it wouldn't actually have much effect, so that's why it's a
Senator Marshall: One last question: Is this the first time you paid a
dividend to the government?
Mr. Zielonka: It is.
Senator Marshall: Ever?
Mr. Zielonka: Ever.
Senator Marshall: So that's $145 million in income for the government?
Mr. Zielonka: Correct.
Senator Marshall: Thank you.
Senator Galvez: From a social perspective, my background is as a
professor of university, and I deal with millennials and with the Z generation.
They are engineers. They tell me they will not be able to own a house. How true
is this? I'm talking about Canada-wide, because I have students in B.C. and
Mr. Zielonka: I don't know how true it is. It is becoming much more
challenging in cities like Toronto and Vancouver. Housing affordability is
becoming extremely challenging, as we've seen house prices rise. Part of the
national housing strategy the government has announced, which has a focus around
affordability and so on, to a certain degree is to try to address those issues.
The issues around affordability are driven not only by demand, which creates
prices to go up, but also by supply and ensuring there is adequate supply. That
has been a challenge in some of our large cities.
The lady from the IMF mentioned earlier that Canada's housing market, at
least three housing markets — it's probably much more than three housing
markets. Vancouver and Toronto have experienced significant increases in house
prices, but we also have experiences with a lot of other markets in Canada that
have had much more modest increases. It's really dependent on which market you
look at. But I think young people are having increasing challenges. That is a
fact, and it is something that I think is of concern.
Senator Neufeld: Thank you for being here. Senator Marshall asked most
of the questions that I had around the dividend.
Have your loan insurance and securitization guarantee rates risen in the last
while? Are they the same today as they would have been five years ago? I imagine
they are different for different types of loans, but have they increased enough
to actually pay this $145 million in a quarter and then another bunch at the end
of the year?
Mr. Zielonka: The way I would answer that is price increases have
happened in all our programs. However, they are independent of the dividend
because what we're paying out in dividends is a business that we essentially
wrote and put on the books over the last 20, 25 years and more. We have been
making significant net income. Just in the last 10 years alone, we have
contributed somewhere in the range of $20 billion to the government's bottom
line through both our net income and taxation.
The dividends we are paying in terms of what we are considering a special
dividend is really a catch-up for past income. In terms of the dividend we are
paying on a quarterly basis, it is really the business that we wrote in the
Regarding business we write today, once that business evolves, which takes
time, you don't have a profit from that business right off the bat. You earn it
over time. It's only once you earn it do you actually have the option of having
that available for dividends to the government.
I'm not sure if that fully answers your question.
Senator Neufeld: So $145 million for the first quarter would be about
$600 million in the year. Is that what you would say? Is that the way things are
Mr. Zielonka: We would expect actually much higher than that. The way
we have approached the dividend is we are looking at paying about half our net
income in the first quarter and then we would see that rising through the year,
so a bigger proportion of net income as the year goes on.
I would also note that the payment of the dividend doesn't have any impact on
the fiscal bottom line of the government. All our earnings are consolidated. As
we make income, that income is recognized as part of the government's fiscal
position, essentially part of the fiscal surplus of deficit. The dividend is
really just an accounting, essentially. We just pay cash over to the government
and the government has that on their balance sheet instead of us having it on
our balance sheet.
Senator Neufeld: Rather than raise your rates, you could drop them so
that people could access housing easier, right? When I said $600 million, I
thought that was quite a bit, but you said it would be way over that. That
doesn't take into account the special dividend at the end of the year.
Mr. Zielonka: What we charge for our rates I believe is the right
approach. It is risk-based. We look at our rates based on the risk we are
talking. Our risk is over a longer term. We look at what we expect would be the
risk over a term of our mortgage insurance contract, which can be 25 years.
In the securitization activity, we charge a guarantee fee for that activity.
It is really for an extreme catastrophic event. You cannot predict when that
will happen. When that does happen, you want to have the resources to be able to
cover that loss rather than paying that out in dividends earlier, if they are
not earned, or for subsidizing a risk that you shouldn't be doing.
We are trying to manage this prudently on a commercial basis and are really
charging prices that reflect the risk we are taking on.
Senator Neufeld: Even though you are paying that amount back to the
Government of Canada, you still have enough money to take care of a catastrophic
Mr. Zielonka: We do; absolutely.
Senator Neufeld: I have one more question to Ms. Bowers.
When the IMF was here, they talked about using 2 per cent above what the
rates are now. Is that part of what you would also use, 2 per cent above? What
would you use for, say, a catastrophic event?
Ms. Bowers: When we do our stress testing, we take into consideration
the interest rate aspect of a sudden increase in insurance rates.
Senator Neufeld: Is it about 2 per cent?
Ms. Bowers: That's a fair amount.
From our perspective, what is more important for us for driving large losses
at CMHC is dramatic increases in unemployment coupled with house price declines.
Those are the two factors that really drive the losses. As long as people have a
job, the historical evidence shows they can usually make their mortgage
payments. We find that if we focus on those two aspects, that is what gets the
large losses in our stress models. That's our focus in terms of that.
Senator Neufeld: When was the last time you had a catastrophic event?
Ms. Bowers: I think one of the senators asked about the big risks that
Senator Neufeld: No, but when was the last time you had a catastrophic
Ms. Bowers: I talked about a 30 per cent national house price decline.
In Canada, we have never had that, luckily — knock on wood. We don't have a lot
of historical precedent in Canada and our mortgage market is not like the U.S.,
but one of the challenges for us is making sure we understand the nature of the
exposure to Canada. That's what makes it challenging. Stress testing is an art
and a science, and we challenge ourselves to make sure we understand that we
have the best models in place and the best expertise to understand the bad
things that could happen in this space.
Senator Neufeld: You said CMHC was created in the 1940s?
Mr. Zielonka: In 1946.
Senator Neufeld: You have not had a catastrophic event since 1946?
Mr. Zielonka: We have not — not that I'm aware of.
The Deputy Chair: Some years back, we had two banks crash. I think one
was Northland. In 1985, Northland, and there was another one called Canadian
commercial or something. I remember that very well.
Mr. Zielonka: There have been failures of financial institutions. I
wouldn't call those catastrophic events. That is something that happens.
We had a bank failure last year, Maple Bank, and we handled that. There was
no impact on us. There was some additional work, but it didn't have any
bottom-line impact to either CMHC or the government for that matter.
It's trying to manage the portfolio of risks that we have. If there was a
major bank failure there may be some costs, but our role is to also be a
stabilizer in the marketplace. Being able to step up is a key factor.
To expand on something mentioned by Senator Neufeld, one of the interesting
things regarding an increase in interest rates is we don't see that as being a
big driver of losses for us. Consumers will continue paying their mortgages, but
the bigger concern would be that their ability to purchase goods and services in
the industry may be reduced as part of that. I think that is the potential
concern because consumer spending will have an impact on GDP growth. That's the
part that is a worry. And the higher debt levels that you see, that becomes more
of a concern, because that exposure becomes greater. That's where the IMF and
Moody's, to a certain degree, are coming from when they see the rising levels of
Senator Forest: With regard to work and performance, there is the
issue of dividends, but financially, the return on investment is substantial.
You said you are responsible for advising the Government of Canada on housing
matters. We are talking about stress now, because many young families would like
to go back to — In the era of suburbs, young families dreamed of living on a
small farm not far from the city with a paved driveway and a pool in the
backyard. Now we are seeing the opposite, young families who would like to live
downtown so they can have just one car instead of two and not have to drive as
far. This market is primarily big developers, especially luxury condo buildings,
where most of the owners are quite affluent.
Could the Canada Mortgage and Housing Corporation not offer incentives along
with the housing services offered? Even in large urban centres and in
medium-sized cities, there are very few housing units with five rooms, for
families, for instance. This is really an issue when you look at current values
in Canadian society as regards the environment and longer travel times. Those
people do not have access to that type of housing right now. They live further
and further away from downtown. To pick up on what Senator Galvez said earlier,
there is no social responsibility to offer incentives to repopulate our downtown
areas with young families who can keep our urban centres alive and ensure they
are developed in line with their values. The issue of dividends concerns me
because they are usually paid to a corporation, which is capitalized by shares.
That means that CMHC has capital stock owned by the Canadian government, isn't
that right? You may reply in sequence or not.
Mr. Zielonka: That is not an easy question to answer, because there
are various aspects. We are seeing profound demographic change in Canada,
especially in big cities such as Toronto, Montreal and Vancouver. That is why a
good many young people want to live downtown. That is why there are so many
condo buildings. As an institution, we have an obligation to give all Canadians
access to housing.
There are different kinds of access, and it is possible to be an owner or a
tenant. We want to offer all types of access.
Our payment of the dividend has no impact in terms of the appropriations and
what the government decides in terms of where it wants to focus its resources.
The government has put forward a very ambitious plan through the National
Housing Strategy that will have an impact on all these different things in terms
of helping Canadians have more flexibility and choice in housing.
Our ability to actually impact housing on a municipal level and how Canadians
access that is much more limited because it's both municipal, provincial and
then jurisdictions rather than the federal jurisdiction. So as a government
agency we stand by with being able to help with implementing government policy,
but we are somewhat limited.
We can do things through some of our programs. In our mortgage insurance
product — I don't have the number offhand — first-time homebuyers are more than
half the people who actually access our mortgage insurance.
We try to be there for all Canadians, but the changing demographics and the
changing environment make it somewhat challenging sometimes.
I'm not sure I fully answered your question.
Senator Forest: That is indeed a major challenge. Even before CMHC
became a key partner which, since a few years ago, no longer intervenes at the
municipal level, it is clear that municipalities offer social housing to help
vulnerable clients. My question is not so much about social housing clients, but
about young couples who do not have the same values today as people did in the
past, such as when I was young. It was all about the suburbs. Nowadays, young
families want to be downtown again, but can they afford it? We are seeing this
in all major cities, regardless of their size — even in Rimouski. Access to
suitable housing for families is truly limited, let alone social housing.
Mr. Zielonka: Mortgage insurance for multifamily housing is a concern,
because many of its activities focus on condos and row houses.
Senator Forest: Townhouses.
M. Zielonka: Yes. It is not possible to get a three-bedroom home
downtown with a 100 square-foot backyard. It is not realistic. I think there is
a gap sometimes between young people's ambitions and reality.
I used to live in Europe, and the difference in what a European would
consider luxury housing and what we would consider luxury housing in Canada is
quite apart. A 300 or 400 square-foot apartment would be perfectly acceptable,
and people would be very happy with it in Europe. Here in Canada, often that is
something that is challenging. And the 1,600 square-foot family home that our
parents may have raised many of us in, which was acceptable, is no longer the
case for many younger people.
There is a bit of a gap that we're struggling to address. I'm not sure how to
deal with that challenge.
Senator Forest: Being aware is the first step in finding a solution.