PrefBlog

An Assiduous Reader writes in and says:

I know how much you love to play the guess the ACM game. But here’s a new twist: what do you think the ACM of your favourite DTI’s are after OSFI requires all the billions of dollars of CMHC NHA MBS to be consolidated back on balance sheet? [link])

But here are some more interesting questions:

• -why has no OSFI regulated publicly traded company commented on how this proposed change will affect their ACM? (home capital got through their entire earnings call without any mention of the ACM) they’ve obviously done the work (IFRS has been planned for years) but have chosen not to share their findings with investors.
• -why has OFSI or the government (although perhaps this is too technical to score political points) not provided any timely clarity on this issue given the importance to the entire mortgage and residential real estate market? (The draft advisory was dated october 2009)
• -will the government/cmhc allow the mortgage business to simply move into lightly capitalized unregulated vehicles to avoid the new OFSI rules? (i.e. is it OK to setup a shell company with $2MM in it that issues $10B in MBS pools?, do we really want the majority of mortgage origination occurring in the unregulated space as a public policy matter?)

A glossary will be helpful here:
OSFI : Office of the Superintendent of Financial Institutions
DTI: Deposit Taking Institution
FRE: Federally Regulated Entity
MBS: Mortgage Backed Securities
CMHC: Canada Mortgage & Housing Corporation
ACM: Assets to Capital Multiple
CGAAP: Canadian Generally Agreed Accounting Principles

The advisory states:

OSFI notes that off balance sheet assets under CGAAP have, during the recent financial turmoil, resulted in DTIs increasing their balance sheet assets during times of stress in respect of assets that no longer qualified to be derecognized and securitization conduits which were no longer exempted from consolidation. Lessons learned in the recent financial turmoil are that certain securitization structures did not transfer the risk out of the FREs as expected. OSFI is of the view that securitization assets which are not derecognized or which are not exempted from consolidation should be included in the calculation of the ACM.

Given that the implementation of IFRSs is expected to increase FREs’ on balance sheet assets and therefore to increase the ACM of DTIs and the borrowing multiple of cooperative credit associations, OSFI is of the view that, in some cases, an immediate application of those rules may be difficult for FREs to meet.

Insured mortgages securitized through the Canada Mortgage and Housing Corporation’s (CMHC’s) National Housing Act (NHA) Mortgage Backed Securities and Canada Mortgage Bond Programs (MBS/CMB Programs) are unlikely to achieve derecognition and will therefore be brought on balance sheet under IFRSs. To facilitate compliance with the ACM under IFRSs and permit an orderly transition, OSFI will permit mortgages sold through the MBS/CMB Programs up to and including December 31, 2009 to be excluded from the ACM calculation when IFRSs are adopted, regardless of whether they are brought onto the balance sheet under IFRSs. If so, FREs will be required to exclude pre December 31, 2009 MBS/CMB programs from the assets in the ACM calculation. However, to create an ACM which is more consistent and which reflects the lessons from the recent financial turmoil, MBS/CMB exposures occurring after December 31, 2009 will be included in the calculation of the ACM under the current ACM definition and limits; that is, they will be included in the asset definition of the ACM upon implementation of IFRS if (but only if) they are accounted for as on balance sheet exposures under IFRSs. No changes will be made to the non capital regulatory returns and FREs will be required to report in accordance with IFRSs; FRFIs will be required to adjust their assets included in their ACM calculation to give effect to the transition provisions.

Footnote: Irrespective of the IFRS determination of what is on balance sheet, the ACM should reflect the MBS/CMB originator’s risk profile. Where the risk profile of the MBS/CMB originator is not materially improved by participation in such a securitization, continued inclusion in the ACM may be appropriate.

Overall, this is not an enormous problem. OSFI reports that the Assets to Capital Multiple for all domestic banks was 15.58x as of 3Q09, with total capital at about $161-billion. The special NHA MBS buying programme is $25-billion and the CMHC had about $200-billion assets on the 2008 books … so consolidating the securitizations will add another multiple of 1 to the total ACM for the system.

As the Assiduous Reader points out, though, there could be trouble at the margins, particularly with specialty lenders; additionally, OSFI has shown in the past that it is incapable of running stress tests that include attention to the ACM.

This one bears watching …

This entry was posted on Tuesday, February 16th, 2010 at 3:32 pm and is filed under Reader Initiated Comments, Regulation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.