UPDATE 3-Canada buys C$5 bln in mortgages from banks

(Updates with comment on auction results)

OTTAWA, Oct 16 (Reuters) - The Canadian government bought C$5 billion ($4.2 billion) of mortgages from financial institutions on Thursday, giving them more cash to make loans and try to overcome the severe constraints in global credit markets.

Ottawa, acting through government-run Canada Mortgage and Housing Corp (CMHC), plans to buy up to C$25 billion in the securities, which mature in five years. The aim is to help banks raise longer-term funding, which has been expensive in recent months, so that they can make more loans available to Canadian businesses and consumers.

The newly reelected Conservative government has vowed not to spend more of taxpayers' money in helping banks and in fact, may stand to make a profit as it designed the auction so that the return on its investment will be higher than its borrowing cost.

The average yield on the auction was 4.241 percent, with a high yield of 4.679 percent and a low yield of 4.041 percent.

Earlier on Thursday the CMHC had said it would only accept offers with a minimum yield of 3.925 percent.

CHMC did not say which institutions offloaded the mortgages from their balance sheets or how much was offered in total. Each issuer was allowed to sell up to C$1.25 billion.

The fact that the low yield was well above the minimum indicates that there was decent interest in the auction, but the bidding also spanned a wide range, said Mark Chandler, fixed income strategist at RBC Capital Markets in Toronto.

"There was a fairly wide dispersion of bids, so you can imagine that there's a handful of institutions that have a greater need for that liquidity (than others)," he said.

The wide range could also reflect the fact that the CMHC auction process is new, he added.

"In future auctions. there may not be that same sort of disparity," Chandler said.

The assets bought by the government, known as National Housing Act mortgage-backed securities or NHA-MBS, are pools of mortgages issued by banks and other financial institutions and are considered low-risk investments because the mortgages are insured against default by CMHC.

Also, Canada's housing market is relatively healthy compared with that in the United States so risk of default is seen as minimal.

The government has not yet announced the full schedule of these "reverse auctions".

Some banks have put up their NHA-MBS securities as collateral for obtaining central bank liquidity in the past few weeks. The Bank of Canada will give them a chance on Monday to free up those securities so they can be sold to the government in future auctions.

Prime Minister Stephen Harper and Finance Minister Jim Flaherty have both hinted that the government is studying a series of other options for aiding banks, with analysts predicting they will introduce guarantees for interbank lending. Harper said on Thursday any move would not involve a significant outlay of public money. ($1=$1.18 Canadian) (Reporting by Louise Egan and Lynne Olver; Editing by Peter Galloway)