Canada plans limits on the use of portfolio mortgage insurance

OTTAWA (Reuters) - The Canadian government intends to introduce some limits on the use of mortgage insurance, a move it hopes will increase market discipline in residential lending and reduce taxpayer exposure to the housing sector.

The changes, announced in the federal budget on Thursday, will not have a direct effect on consumers wanting to take out mortgages. But it could cause banks to raise their rates or limit their lending.

Portfolio insurance is taken out by financial institutions on pools of mortgages to reduce their exposure to defaults. Banks significantly increased their purchase of such insurance from the Canadian government’s housing agency during the financial crisis.

The first change announced in the budget will be to limit the use of such insurance on portfolios of low-risk mortgages, or those with a low loan-to-value ratio. High-ratio mortgages, with down payments of less than 20 percent, are already required to have insurance, but banks can also take insurance on a portfolio of low-ratio mortgages.

The new rule will gradually limit the insurance of the low-ratio mortgages to only those mortgages which will be used in securitization programs of the federal housing agency, the Canada Mortgage and Housing Corp (CMHC).

The measures reflect concerns that banks had begun to use portfolio insurance for new purposes, such as capital and liquidity management. The budget document said this was not the intended purpose.

The government said it was possible to introduce the new rule now because the financial crisis was past.

Finance Minister Jim Flaherty has tightened mortgage rules four times since 2008 in a bid to cool a Canadian housing market boom that has taken household debt to record levels.

The second rule revealed on Thursday will “prohibit the use of any taxpayer-backed insured mortgage, both high and low ratio, as collateral in securitization vehicles that are not sponsored by the CMHC,” the budget document said.

“These measures will restore taxpayer-backed portfolio insurance to its original purposes of allowing access to funding for mortgage assets,” it said.

The government will consult with the industry on the timing of the new measures.

Reporting by Randall Palmer; Editing by Louise Egan and Jeffrey Hodgson