In our last blog, we looked at the first glimmerings of disruption in Canada’s loan marketplace by peer-to-peer (P2P) lenders.
But what of disruption in the unregulated “shadow banking” mortgage marketplace?
Canada’s small but growing non-bank mortgage market hasn’t yet been disrupted, largely because so-called “shadow banking” isn’t digital to any great degree. While there are players in the P2P realm, there’s no platform in place to scale a market to meet the demand for P2P loans, certainly not compared to UK’s www.zopa.com, which accounts for some 40% of the auto loan marketplace and much more besides….
Semantics count; at around 10% of the Canadian mortgage financing, “shadow banking” has been around for decades, better known as “alternative lending” or “lenders of last resort.” True, it’s a murky world, messy and hardly transparent, but it’s growing. Moreover, Canada’s secondary mortgage marketplace is more accurately termed “subprime non-bank” mortgage lending—because that’s what it is.
It’s also likely the result of a half-dozen federal oversight regulations that pushed desperate borrowers into the world of non-bank lenders, where mortgages deals are in many cases (but not all) like the Wild,Wild West.
And while borrowers can who wisely use non-bank financing to save their homes with otherwise unavailable high-risk refinancing, the reality is that non-bank lending is often predatory. It’s also an accelerant towards bankruptcy and foreclosure for those desperate enough not to lose their homes and willing to pay upwards of 15% to 20% or even more for uninsured, short-term mortgages. (There are reputable, federally regulated lenders in the non-bank sector, to be sure, but the growth in the space is in high-risk, unregulated lending.)
It’s hardball lending, the way predatory credit card companies play the game.
Non-bank lending skirts regulatory oversight; punitive fees for late or missed payments are one ethical issue. The other is that the pre-crash US subprime market was 30% of the mortgage market nationally but far higher in the “twilight zones” of California, Nevada and southern Florida, where entire suburbs were underwater.
Here at home, some financial analysts believe that the Canadian real estate market’s steady climb has papered over some very shaky financing indeed, in markets hot and cool alike.
The fragility of these subprime loans, once a minuscule but lucrative bank sector for Wells Fargo, Citibank and HSBC before 2008, stands to increase once interest rates start to climb again.
Now this is all good news for savvy investors, because a bet on a working family refinancing to keep their home is a bet against rising property values, even to the tune of three and even four mortgages.
The Bank of Canada’s most recent Financial System Review used some pretty pointed language about the space, observing that “opacity is a particularly important vulnerability.” The Bank defines opacity as “the degree to which information is not available about institutions and markets, such as asset holdings, counterparty exposures, prices and volumes traded and (EXPERT/ease emphasis) the characteristics of financial products.” Beneath the bureaucratic language is a warning: private-label securitization is only as good as the due diligence on the “type and quality of the underlying assets.”
In other word, to quote the legendary Stephen Leacock in another context: “if you can’t see it, it probably ain’t there.”
Let the buyer beware: there are sharks lurking in those waters. And the latest reliable statistics suggest home loans from non-bank lenders are growing about 25% annually.
There’s no doubt this lending meets rising demand; in Europe, led by Ireland, Lichtenstein and the Netherlands, the non-bank investment funds are doing big business as the eurozone debt crisis shakes out. The real question—and only time will tell—is what the historic risk created by that demand truly is, Canada as well as Spain or Greece.
Even calculating that risk, as Irish market supervisors at the Irish central bank note, just defining the “non-bank lending” industry is difficult, because there’s no detailed balance sheet information, because the institutions behind the lending are often holding companies for derivatives. Canadian investigators and legislators in the non-bank lending space would do well to learn from the Irish experience.
Mapping this uncharted territory is the first task of regulators. Irish opposition politicians, for one, know that legislators are building a potential financial Frankenstein, enticing offshore “shadow banks” to Ireland even while Irish bank regulators struggle to map out the operations already in Ireland’s markets. Canada’s problems are simpler but will likely be no less toxic when rates climb back again.
Crystal ball? Expect more federal oversight, with a tough focus on and, if rates climb fast enough in 2016, crashes in housing prices in particularly creaky markets. Warren Buffet’s wry warning suffices: “You never know who’s swimming naked until the tide goes out.”