Risky mortgages, shadow bankers threaten Vancouver housing market’s stability
Vancouver?s hot real estate market is plagued with another concern that shows similar characteristics to the fraudulent loans exposed in the U.S. in 2008, writes Sam Cooper
Sam Cooper
The Vancouver Sun
Massive and risky home loans are increasing in number across Metro Vancouver, while mortgage fraud cases are also on the rise, connected to the growth of so-called “shadow banking,” a Postmedia investigation shows.
The trend of increasingly risky loans underlying Metro Vancouver’s high home prices is illustrated by Bank of Canada figures that show the rapid growth since 2014 of large mortgages made to people with relatively low incomes.
This is a growing danger for Vancouver’s real estate market, because under new tighter lending standards introduced for banks in fall 2016, the Bank of Canada says that many of these big mortgages can no longer be insured, and won’t be issued again by federally regulated lenders.
As a result of the tighter federal lending rules, borrowers trying to buy million-dollar-plus properties in Vancouver’s market are increasingly taking out dangerous loans from shadow bankers in a fast-growing and poorly regulated financial market.
There is also evidence of growing links between shadow banks and traditional banks, according to the Bank of Canada’s June 2017 report, as people borrow large amounts from shadow lenders to use as down payments in order to qualify for lower-interest loans from federally regulated banks.
“Price increases in Vancouver and Toronto have an element of speculation to them,” Bank of Canada Governor Stephen Poloz said last week, while issuing the bank’s biannual financial system review. The review showed “riskier characteristics are increasingly evident” in new mortgages.
A December 2016 Bank of Canada report estimates shadow lenders now account for $1.1 trillion in debt — about half as much as the traditional banking sector — and that over the past decade “these new players have become more important and have changed the face of the Canadian mortgage market … (as) tightening bank regulation can lead to migration of activity from the traditional banking sector to the shadow banking sector.”
Shadow lenders are non-bank lenders that increase the supply of credit in Canada’s financial system, without facing the regulatory oversight of banks. Critics say shadow banking is vulnerable to loose lending standards, mortgage fraud, money laundering, and collateral that is overly leveraged (also called re-hypothecated) — meaning debt backed by property assets is used over and over again by related lenders to issue more home loans, in ever riskier chains of debt.
Shadow lenders identified by Postmedia through a review of B.C. civil court filings, lending documents and regulatory filings, include mortgage investment corporations, hedge funds, and private lenders such as realtors, crowdfunding companies, real estate lawyers and mortgage brokers.
A number of cases involving these lenders contain allegations with characteristics similar to the fraudulent loans exposed in the aftermath of the U.S. subprime lending crisis of 2008. Postmedia’s review of over 30 regulatory or civil court cases shows a trend of allegations that home buyers and real estate professionals are involved in deceptive mortgage applications that include exaggerating the incomes of borrowers, forged documents of home ownership used by multiple borrowers to obtain mortgages, phoney claims of offshore assets used to back home loans, falsely inflated collateral accepted by subprime lenders to fund real estate development loans, and falsified CRA tax return documents.
For Hilliard MacBeth, an Alberta-based author and wealth manager, the Bank of Canada loan risk statistics and the related growth of shadow banking in Vancouver and Toronto herald a crisis.
“These properties in Vancouver are so expensive that you need people either laundering money or loan fraud or people borrowing such large amounts of money that should never be allowed, in order to keep it going,” MacBeth said. “If everyone is reporting their incomes honestly in Vancouver, there is no way that housing prices can stay where they are.”
In B.C., the provincial regulator B.C. Financial Institutions Commission, known as Ficom, is in charge of monitoring the growing shadow banking sector. Postmedia’s review of Ficom enforcement hearings shows an increase in the number of alleged mortgage fraud cases in B.C., mostly linked to private mortgage lenders and mortgage brokers.
“We have experienced an increase in mortgage broker complaints in the last few years,” Chris Carter, acting registrar of mortgage brokers, confirmed. “About a third of our investigations relate to application fraud.”
The Bank of Canada warns of two key risks in Canada’s housing market.
The first is that property prices and household debt have reached such extremes in Vancouver and Toronto, that “just about anything” could trigger a correction, Poloz said last week. Highly indebted borrowers could be forced to sell in a correction, the Bank of Canada says, leading to further selling, tighter lending, and a potential domino effect on banks and shadow banks.
The other elevated risk is the potential for a shock from China’s volatile economy. China has its own shadow banking problems, the Bank of Canada says.
In China, “linkages between the banking and shadow banking systems are also becoming more complex and opaque, increasing the underlying credit risk,” the Bank of Canada’s December 2016 risk report says. “The experience of the 2007-09 global financial crisis showed that financial stability can be threatened by vulnerabilities originating in the shadow banking sector.”
As a result of the flood of money pouring from Mainland China into Vancouver real estate in recent years, some financial experts say they believe Canadian banks are directly exposed to shadow lending in China and the risks of so-called “ghost collateral” — meaning collateral that may not exist or is used continuously to secure loans for multiple borrowers.
Postmedia confirmed that Canadian banks are allowed by the federal regulator, the Office of the Superintendent of Financial Institutions, to accept collateral from China to secure real estate mortgages in B.C.
“OSFI does not dictate what type of collateral (federally regulated banks) can accept,” spokeswoman Annik Faucher said. “Whether the borrower is foreign or domestic, OSFI (allows) financial institutions to compete effectively and take reasonable risks.”
One U.S. hedge fund manager, who did not want to be identified, said: “We all know that the ghost collateral is a huge deal, and we all know that the shadow banking and other Chinese influence in Vancouver is profound. The issue it that the ghost collateral ends up re-hypothecated and laundered. So by the time it shows up in Vancouver, it will likely just look like a rich Chinese cash buyer with a suitcase of money. “
RISKY LOANS SPREAD
The spread of high risk loans in Metro Vancouver can be seen in Bank of Canada maps that show where new ‘high-ratio’ loans — meaning the buyer makes less than a 20 per cent down payment on a home purchase and borrows the rest — have been issued. If the value of the loan is 450 per cent of annual income or more, the borrower is considered particularly vulnerable. The Bank of Canada will not reveal the number of high-ratio loans issued in Metro Vancouver, but says they are concerned with the rapid growth in these loans. In 2014, across Metro Vancouver, 31 per cent of new high-ratio mortgages were at least 450 per cent of the borrower’s income. In the second half of 2015, this figure rose to 37 per cent. By late 2016, it was 39 per cent.
The Bank of Canada says that under the new tighter federal rules, about 43 per cent of the high-ratio loans issued in Vancouver between September 2015 and September 2016 would have been rejected. This means either that an increasing portion of buyers in Metro Vancouver will be unable to get loans in the future or that the shadow lenders will fill the void.
There are four areas across Metro Vancouver in which more than 50 per cent of new high ratio loans are above 450 per cent loan to income. In an indication of rapid price rises or extreme speculation, South Vancouver, a neighbourhood bordering Granville Street and just north of Richmond, had an explosion in high ratio loans in 2016, from very few in 2015. The other three areas at the top of Bank of Canada’s risk scale, at over 450 per cent loan-to-income, are Burnaby’s South Slope neighbourhood, a northern part of Richmond, and a northern part of Delta.
GROWTH OF SHADOW BANKING AND GHOST COLLATERAL
Shadow lending can be as simple as a mortgage loan provided by one person to another in need of financing, or as Byzantine as the complex processes through which credit is created and exchanged and repackaged between various lenders to fund mortgages.
For example, the director of a Surrey lumber and real estate investment company explained to Postmedia that his group’s business model consists of pooling the real estate assets of an extended group of family and shareholders, and using these homes as collateral to borrow money from financial institutions. The borrowed capital is then issued in mortgages to home buyers that can’t obtain financing from chartered banks.
In another example researched by Postmedia, lending documents show that controversial “crowdfunding” developers are using single-family homes owned by investors in Vancouver to secure loans from subprime lenders that are active in B.C. in order to fund condo developments in Vancouver and Burnaby.
Ben Rabidoux, a Canadian analyst who provides market research to U.S. investors that are betting on a sharp correction in Canadian housing, said that his research with on-the-ground mortgage brokers suggests that loan fraud is a systemic concern in Ontario and B.C.
“The shadow market is absolutely booming,” Rabidoux said. “Of course B.C. has a mortgage fraud problem, but you won’t really see it until there is a problem with collateral in the system.”
Ghost collateral is explained in a recent investigation from Reuters that concludes that China’s financial system faces a potential collapse similar to the U.S. subprime mortgage crisis of 2008, due to “massive credit expansion,” and “collateral risks” connected to $17.2 trillion in outstanding loans as of April, up from $5.8 trillion in 2009.
The report says that 60 per cent of all loans issued in China’s system are backed by property, and that China’s property values are “wildly misleading” — which is part of the reason that China’s credit rating was recently downgraded. Reuters reported that Chinese lenders are prone to fraud “with loan officers turning a blind eye to the quality of collateral and knowingly accepting dubious and even fraudulent documents.”
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