Canadian Banks Will Exploit Gutted U.S. Mortgage Underwriting

Canada’s banks are in trouble. Their mortgage portfolios are filled with time-bombs called “fixed-payment” mortgages. Despite the name, the loans contain rate-hike triggers that are causing payment shocks for borrowers. High interest rates and falling home values mean borrowers north of the border aren’t able to refinance out of these toxic mortgages.

Short sellers are even targeting one Canadian bank, Toronto-Dominion Bank, better known as TD Bank. It’s fast becoming the GameStop of banks.

Canada’s banks, says one source south of the border, are now looking to hedge their bets. To that aim, they want to increase mortgage originations at their existing banks in the United States and to acquire new regional banks south of the border. They see the newly dismantled underwriting safeguards and risk-shedding experiments at Fannie and Freddie as a way to keep the party going, with the risk passed along to the U.S. taxpayer directly and as systemic risk in the global economy.

The $13.4 billion takeover bid of Memphis-based First Horizon Bank by Canada’s Toronto Dominion Bank is likely part of that strategy, says the source. TD has also stepped up its charitable giving to U.S. housing nonprofits in anticipation of the coming bonanza. The takeover bid is now under a regulatory microscope due to the recent bank collapses in the United States.

The problem with Canada’s “fixed-payment loans? The amortization schedule changes behind the scenes when rates go up or down. All the while, payments remain fixed – that is, until high index rates threaten to take the loan into negative amortization territory. That triggers the “fixed payment” to adjust, resulting in a payment shock.

In November 2022, one-third of Canada’s total outstanding mortgage debt was in variable-rate loans, up from one-fifth in 2019. According to the Bank of Canada, most variable-rate mortgages have this fixed-payment feature. Other Canadian mortgages are reported to have fixed rates for only the first two to five years.

By November of last year, half of all such mortgages had hit their trigger rate, estimated the Bank of Canada. By February of this year, as many as 80% of variable-rate mortgages had hit their trigger rate, estimated National Bank Financial economists Stefane Marion and Daren King.

Several Canadian banks have established a presence in the United States over the years through acquisitions of existing banks or by opening new branches. TD Bank has expanded its presence in the northeastern United States through a series of acquisitions, including Banknorth, Commerce Bancorp and Carolina First Bank. RBC (Royal Bank of Canada) has grown its U.S. operations through the acquisition of City National Bank, a California-based bank that focuses on serving high-net-worth individuals and businesses.

Other Canadian banks with a presence in the United States include Scotiabank, BMO (Bank of Montreal), and CIBC (Canadian Imperial Bank of Commerce), among others.

Certain mortgages will reach their trigger rates sooner. Those that were originated or renewed in 2021, for instance, will tend to reach their trigger rates earlier, mainly because they were issued at extremely low interest rates and often with amortization periods longer than 25 years. Households that took on a 30-year mortgage during the Covid 19 pandemic when variable rates were extremely low will generally see a larger increase in mortgage payments.

In Toronto, mortgage volumes fell by 44.3% year over year. In Vancouver, they fell by 52.3% year over year. As the newsletter Quill Intelligence pointed out in December, Canadian households’ debt-to-GDP ratio pierced 100% in 2015 and has remained there.

One observer involved in banking services, who asked his name not be used, sees TD’s play to acquire First Horizon Bank as part of the effort to cash in on the moral hazard created by Fannie and Freddie’s dismantled underwriting norms.

Recently, under the protective camouflage of their federal conservatorship, Fannie and Freddie began eliminating critical checks and balances in a radical experiment with U.S. taxpayers’ money and the U.S. economy on the hook. Fannie has scrapped or weakened long-accepted underwriting safeguards like standard FICO scoring, title insurance, mortgage insurance, downpayments and appraisals.

Fannie is even encouraging a new form of the “liar loan,” a product promoted with a perfectly straight face by mortgage brokers during the lead-up to the 2007-2008 financial crisis. Fannie’s new liar loan, called “Value Acceptance,” accepts a collateral value pulled out of the ether by the lender or a third party with a stake in gaining a commission or pleasing the customer. But don’t worry. Fannie checks the stated values against its algorithm – the equivalent of a “Zestimate.”

Fannie then dumps the resulting risk into capital markets via junk-rated credit default swaps it calls “CRTs.” This practice is relatively new for Fannie, which has found itself propping up an over-the-counter marketplace for the synthetic derivatives.