Risk of mortgage defaults puts spotlight on Canadian non-bank lenders

Houses are seen on a hill in Vancouver, on Thursday, November 23, 2023. THE CANADIAN PRESS/Darryl Dyck

Toronto — Small, loosely-regulated lenders in Canada who rode a pandemic housing boom to offer mortgages at high interest rates are now showing signs of stress as a spike in living costs pushes some homeowners toward a default.

Canada's C$2 trillion ($1.5 trillion) mortgage market is dominated by the "Big Six" major banks that include Royal Bank of Canada and TD Bank.

But for many Canadians unable to pass a rigorous test to qualify for a home loan, there has long been another option: private lenders who offer short-term mortgages at rates that are several percentage points higher than those charged by big banks.

One subset of this group of lenders - Mortgage Investment Companies (MICs) - has mushroomed in the past three years, taking on riskier deals, when record low borrowing costs pushed up mortgage demand at the peak of a housing market boom in 2022.

But as the real estate market softened in Canada over the past year while the cost of living and interest rates rose, consumers struggled to make their monthly payments, forcing many MICs to sell properties cheaply to recoup losses as homeowners defaulted and property prices declined.

"It is reasonable that the alternative mortgage funds today are experiencing some stress given our markets are adapting to a new normal," said Dean Koeller, chair of the Canadian Alternative Mortgage Lenders Association.

Data from the Canada Mortgage and Housing Corp showed that nearly 1 per cent of mortgages from private lenders were delinquent in the third quarter of 2023 compared with the industry-wide rate of 0.15 per cent.

The market share of newly-extended mortgages by private lenders in the first quarter of 2023 jumped to 8 per cent from 5.3 per cent in 2021, while the share of those lent by big banks fell to 53.8 per cent from 62 per cent, the data showed.

Data provided to Reuters by Toronto-based commercial mortgage brokerage LandBank Advisors also captures some of the stress private lenders are facing.

LandBank Advisors studied over 1,000 mortgages issued between 2020 and January 2024 and found that about 90 per cent of home buyers who were forced to sell their homes because of default in the Greater Toronto Area, Canada's biggest real estate market, had taken out mortgages from private lenders.

MICs generated more than half of the mortgages among the 90 per cent pushed into fire sales.

About 50 such forced sales in the Greater Toronto Area region were registered so far in 2024, compared with 558 in 2023 and 92 in 2020.

On alert

In response to the rise in interest rates since March 2022, the office of the Superintendent of Financial Institutions - which regulates the country's big banks - last year directed them to hold more capital to cover for loan defaults.

But private lenders, which are overseen by provincial governments, face fewer regulations and unlike the major banks, do not require that clients take federally-mandated mortgage tests that ensure they can make payments even if rates go up.

Superintendent of Financial Institutions Peter Routledge, whose office does not directly oversee private lenders, said this month that a "sudden proliferation of unregulated lending" would be a problem but that so far the sector was not growing in a way that gave cause for concern.

The Financial Services Regulatory Authority, which oversees mortgage brokerages, has begun campaigns to protect consumers from unaffordable, high fee mortgages and issued new guidance and tighter licensing requirements on mortgage brokerages.

"Many MICs opened up three or four years ago. The problem is they opened up... when values were at their highest and when you look at their books, a lot of their books are underwater," Jonathan Gibson at LandBank Advisors said.

"MICs are trapped or are becoming more and more picky."

But some well-capitalized and more experienced private lenders see M&A opportunities by rescuing struggling lenders, industry executives say.

Jesse Bobrowski, vice president of business development at Calvert Home Mortgage Investment Corporation, said his firm is on the lookout for acquisitions or loan books to buy.

"Definitely we're looking to expand our market share," Bobrowski said.

(Reporting by Nivedita Balu in Toronto, Graphics by Prinz Magtulis in New York. Editing by Denny Thomas and Deepa Babington)