Canada's Subprime Mortgage Crisis (and it's Bank Failure Friday)

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UPDATE: No failures reported by the FDIC today. They must all be in Europe with Obama.

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Hat tip to Greenhorn for this story.

Convential wisdom (and a dash of Canadian arrogance) has maintained that the Canadian Real Estate market will escape the crisis we are seeing in the United States because our banks did not engage in the disasterous subprime mortgage fiascos.

Well that isn't entirely true.

Most of us are aware that Canada had 0 down/40 year mortgages offered by conventional Canadian banks for a short period of time. A great many young couples jumped into the real estate market with nothing down. Now... with the recent drop in housing prices, all those who bought are now underwater which jeopardizes their ability to renew.

However it appears these are not the only risky mortgages out there. And the problem is far more widespread than most of the public knows.

It seems mainstream Canadian banks weren't the only ones offering risky mortgages and there are a whole range of risky Canadian subprime mortgages we haven't heard about.

In a recent story in the Globe and Mail (Lenders seek Ottawa's aid as thousands risk losing their homes), the paper reports that as many as 25,000 Canadian homeowners - homeowners who consistently have met their mortgage payments and have never missed a payment - could lose their homes unless Ottawa or other financial players help supply capital to the struggling Canadian subprime lending market.

They are Canadians who have mortgages issued by a loose network of about 12 alternative mortgage lenders.

It seems that these alternative mortgage lenders have been lobbying the Prime Minister's Office and the Department of Finance in January about what they say is a looming problem: An estimated $3-billion to $5-billion worth of subprime mortgages are coming up for renewal over the next four years, and the lenders can't renew them because the necessary capital that provides the financing has dried up. And because they are higher-risk borrowers, they will not qualify for mortgages from regular banks.

“These are hard-working Canadians who could face foreclosure on their homes if they are unable to renew or find mortgage financing,” said Paul McGill, the CEO of the N-B Group, an alternative mortgage lender that has been spearheading the campaign.

Apparently these mortgages were arranged in the early 2000s, when investors easily bet money on complex securities backed by mortgages.

Many investors were comfortable investing in Canadian securities with subprime mortgages because of the higher returns these investments offered. The torrent of money flowing into securitized investments, such as asset-backed commercial paper, allowed a new generation of lenders such as Toronto-based Xceed Mortgage Corp. and U.S.-based Accredited Home Lenders Inc. to offer mortgages to Canadians with credit score blemishes.

When the global credit crisis struck in August 2007, investors fled mortgage-backed securities, forcing these alternative lenders to turn to more conventional securities such as Canada Mortgage Bonds, which the Canada Mortgage and Housing Corporation administers.

And because Canada Mortgage Bonds require borrowers to meet higher credit standards to qualify for their investment program, those higher risk homeowners who got mortgages from the alternative lenders are now on the verge of being orphaned... they can't renew these mortgages.

Some of these alternative lenders, such as Toronto's Xceed Mortgage Corp., say they have been forced to start foreclosure proceedings on customers - even thought they are current with their payments - because they cannot find capital financing to take on these mortgages.

Ivan Wahl, chief executive officer of Xceed, said the company has initiated foreclosure proceedings against 200 homeowners, mainly in Ontario and Quebec, because the company was unable to find new money to lend to them.

He said another 1,200 of his company's mortgage customers will be in a similar predicament over the next four years.

Two weeks ago, The Globe and Mail reported that foreclosures in Alberta and British Columbia have spiked, with Alberta's foreclosures on pace to double from two years previous – to 5,300 in the first 11 months of 2008-09 from 2,510 in 2006-07.

Just how many mortgages have been offered to Canadians by the likes of Toronto-based Xceed Mortgage Corp. and U.S.-based Accredited Home Lenders Inc is unknown, but it would appear that Canada is not as immune to the subprime mortgage crisis as the real estate industry would like us to believe.

As these mortgages come up for renewal and default, watch for even more downward pressure on Vancouver real estate prices.