A Second Look at the CMHC

The CMHC guarantee is a direct and unconditional obligation of CMHC as an agent of Canada. It carries the full faith and credit of Canada, and constitutes a direct and unconditional obligation of and by the Government of Canada. – 2010 CMHC Annual Report, p.86 ,
If the above quote doesn't bother you, it should, because it represents a potentially massive amount of debt that will be shoveled on to backs of every man, woman and child in Canada. A government bureaucracy, staffed by unelected functionaries, has pledged over a trillion of your tax dollars as payments to investors should their decisions turn sour.

In The Canadian Moral Hazard Corporation I highlighted the issues faced by the Canadian mortgage and housing market. As a country we're faced with record high levels of debt in both absolute and relative terms, record high housing prices and record low levels of savings. Based on overly-rosy future outlooks, Canadians have by and large become extremely leveraged and could soon have little to show for it.

In order to really understand just what we're facing as a nation and how it will unfold, a closer inspection of the CMHC is needed. It's also instructive to compare the CMHC to other similar organizations. For this comparison, it will be appropriate to use Fannie Mae (FM) in its 2007 incarnation. The CMHC is essentially the Canadian-based clone of FM with only one major exception; the US-government had a choice whether or not to bail them out. FM was 50% owned by the US government and 50% publicly traded. The CMHC is, by contrast, a 100% government-owned crown corporation.

Raw numbers on their own aren't always useful, it's better to look at ratios and leverage ratios give us a good look as to how far down the debt-hole a company has ventured. So without further ado:

CMHC 2010 Fannie Mae 2007
Assets to Equity 25.64 20.05
Guarantees to Equity 73.46 65.63
Debt to Income 18.89 18.73

From the vital statistics above, it's obvious that the CMHC is in an even more precarious position than FM. It is more leveraged in every respect and so the conditions are ripe for a collapse in this company. Its exposures to credit, interest and market risk are extremely high and it appears that little is being done to correct this situation. Little can be done though since the contracts have been signed and promises already made to investors.

Further compounding the situation is the short-term nature of CMHC's debt. Much of which matures over the next few years.

Canada Mortgage Bonds
(in millions of dollars) Amount Maturing Yield
2011 36,152 4.07%
2012 38,956 4.30%
2013 36,128 3.40%
2014 36,025 2.53%
2015 31,008 2.52%
2016-2020 19,219 3.40%
Total 197,488 3.40%

Borrowings from the Government of Canada
(in millions of dollars) Amount Maturing Yield
2011 1,661 2.71%
2012 1,406 3.59%
2013 26,137 3.58%
2014 29,133 2.52%
2015 2,275 3.68%
2016-2020 1,442 7.18%
Thereafter 2,215 8.41%
Total 64,269 3.40%

Interest expenses are the largest line item on the income statement, making up 68% of all expenses. Rising interest rates will quickly wipe out what little net income the CMHC is still making, further endangering the company. If they start realizing losses, the company will either have to start selling off its assets or borrow even more at higher rates, further compounding the problem. Over half the CMHC's assets are made up of mortgage-backed securities that they themselves guarantee. Turning from a net buyer to a net seller of MBS will have a profound impact on the mortgage market.

In fact, it appears that the CMHC doesn't even consider credit risk an issue since they make absolutely no allowances for it. Instead we're faced repeatedly with the statement that "CMHC’s liabilities are backed by the full faith and credit of the Government of Canada and there is no significant change in value that can be attributed to changes in credit risk." When an organization knows that it can get in to debt and guarantee anything it wants in the pursuit of profit, and be able to put the taxpayer on the hook for it all if it goes bad, is it any wonder that this is what happens?

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