It remains to be seen whether the reform fever that is presently sweeping through the US securitization market will continue unabated across the 49th parallel but there is no question that these monumental reforms have given rise to a considerable amount of discussion and debate over the appropriateness of similar reforms in Canada. This was perhaps inevitable given the degree of economic integration between the two countries and the fact that both have recently suffered through significant ABS-induced crises (albeit on entirely different scales).
Although these crises may have shared some of the same root causes, the US proposals for reform appear to have been heavily influenced by the US subprime mortgage meltdown and appear to be intended to address the lack of regulatory oversight that permitted the now much-maligned underwriting and product origination and distribution practices in the US subprime mortgage market that arose amid this regulatory vacuum; practices that were not prevalent (if even evident) in Canada. While a more extensive summation of these practices and the US reform proposals can be found in previous postings by Mike Rumball, given the insular nature of these problems, it is important to assess the Canadian market on its own merits in determining the scope and form of future Canadian reforms. We hope, in particular, that Canadian regulators will carefully consider the strong historical performance of Canadian financial assets in the course of determining the necessity, scope and nature of structural reform.
By any number of empirical measures, the Canadian economy tends to lag behind that of the US (both in absolute terms and in relative comparisons). Although the absolute volumes are difficult to compare given the enormous difference in the size of the respective markets, a review of the performance of some of the major asset classes that underlie the Canadian securitization market (such as residential mortgages, credit cards and auto loans and leases, asset classes that are now commonly referred to in the post-CDO era as "traditional assets") reveals that these Canadian assets significantly outperform similar assets in the US. This being said, US asset performance appears to have suffered from guilt by association with the subprime mortgage market as US asset performance has otherwise been relatively solid.1
Putting aside the subprime mortgage market, prime mortgage defaults began to rise in both Canada and the US in early to mid 2007. Prior to that, Canadian mortgage default rates during the period of 1998 to 2007 were consistently in the range of 0.50% or less, while US mortgage default rates during this period generally ranged from 0.70% to 1%. Canadian mortgage default rates rose to a high of just under 4% by late 2009, while US mortgage default rates peaked at just over 7% by late 2009/early 2010.
Net loss rates for credit cards show that in the 1998 to 2007 period, Canadian loss rates ranged between 2% and 4% while US loss rates for credit cards ranged between 4% and 6%. The loss rates in both Canada and the US began to climb beginning in late 2007/early 2008, reaching a peak of 10.80% in the US in mid to late 2009 and a peak of 6.38% in Canada in late 2009. Payment rates in Canada also significantly exceed those in the US (suggestive of a lower risk profile); over the past decade the payment rates in Canada have generally ranged between 30% and 35%(although briefly dipping as low as 26% at times in 2009 and 2010) while payment rates in the US have generally ranged between 15% and 20% during this period.
The contrast in the numbers for auto leases and loans are also significant. For issuance years 2005 through 2007, US default rates have peaked to date at approximately 1.65% (2005), 2.5% (2006) and 2.75% (2007) while Canadian default rates over the same period have peaked at approximately 0.30% (2005), 0.65% (2006) and 0.85% (2007). For issuance years 2008 and 2009, default rates in the US peaked at approximately 2.50% (2008) and 0.85% (2009) and default rates in Canada peaked at approximately 0.85% (2008) and 0.40% (2009). It should be noted that these numbers do not reflect any residual value losses.
Astute observers of the Canadian market may also ask why I have made no mention of the performance of the assets that were funded by numerous non-bank sponsored ABCP conduits (which ultimately became the subject of the so called "Montreal Accord") and point to this "ABS-induced crisis" as a basis for suggesting that reform is required.While this is a valid question, the assets in these conduits which caused the greatest concern were not traditional assets but "non-traditional" assets such as leveraged credit default swaps and certain assets with exposure to US subprime mortgages.
All in all, the asset performance story in Canada is a very positive one. Not surprisingly, strong asset performance has translated into strong ABS performance.While, as noted, there have been some losses incurred in these traditional asset classes, the credit enhanced ABS structures in the Canadian market have survived the test of time.In fact, apart from certain series of debt restructured in connection with the Montreal Accord, no rated ABS debt in Canada has suffered any losses to date.
There are many challenges facing the Canadian securitization market. The uncertainty created by evolving bank regulatory capital standards and the transition of accounting standards to IFRS have together not only acted as a constraint on growth in the market but as a catalyst for contraction until market participants are able to assess the impact of these changes. While some reform is likely inevitable given the current international environment, we hope that change will not be made simply for the sake of change and that any reform proposals will not create additional uncertainty but will be appropriately tailored to the realities of the Canadian marketplace and recognize that Canadian ABS transactions are fundamentally strong.
Footnotes
1 We gratefully acknowledge that numerical data was provided by DBRS Limited. The numerical figures set out in this article have been rounded or approximated for illustration purposes and are not exact. Any conclusions or opinions expressed in this article are solely those of the author and not of DBRS Limited.
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