How mortgage pioneers sparked $50B revolution

Fifty-billion dollars may not go as far these days as it used to, but it’s still equivalent to a stack of $20 bills 250 kilometers high. Of more direct relevance, $50-billion would buy 142,857 homes valued at $350,000 each – very comfortable housing for about half-a-million Canadians.

I use this analogy because it is also the estimate I am putting on how much Canadian homeowners have saved through lower rates thanks to mortgage pioneers Breandan Calder and Ivanl Wahl.

What did they do? They created a little mortgage company named FirstLine Trust in 1985 from a merger of Canada’s first “mortgage-backed securities” company, GMC Investors, and First Western Trust of Calgary.

What FirstLine did was no small feat. It broke the decades-long stranglehold that the Canadian banking oligopoly had held on residential mortgage rates.

Let’s go back to 1984 when Liberal Financance Minister Marc Lalonde implemented measures in Canada through Canada Mortgage and Housing Corp. to duplicate the huge success of the U.S. mortgage securitization program that had cut mortgage rates by more than a full percentage point.

Securitization “cut out the middle-man,” eliminating the need for full-service banks to fund mortgages with GICs. It allowed big, deep-pocket investors – pension and mutual funds – to invest directly into pools of mortgages originated by brokers and mortgage banks, at superior rates of return to bonds.

The ambitious federal plans in 1984 were met with stoney silence by the banking industry. As was pointed out by Wahl, now CEO of another reconstituted mortgage industry gem, Xceed Mortgage Corp., the banks were united in the “decades-long enjoyment of mortgage rates consistently 200 basis-points above the yields of [equivalent term Government of] Canada Bonds.”

You will get very little argument from experienced Canadian mortgage market observers that this 200 basis point spread has been slashed to 100 basis points almost entirely due to the timely and determined intervention of Wahl and Calder through FirstLine in the mid-to-late ‘80s. That 100 basis points is worth about $50 billion over the past 20 years.

Jay Hennick, now chief executive of FirstService Corp.. was the lawyer who closed the deal that created FirstLine Trust. “Brendan and Ivan were at the root of lower mortgage rates for Canadians, and the did it by taking great ideas that were working well elsewhere – Australia, the U.S., wherever -- and making them work in Canada,” he said

The two biggest ideas were the use of mortgage-backed securities (MBSs) for funding mortgages, and the professionalization of the lowly mortgage brokerage industry to originate business.

MBSs were the government-guaranteed investment instruments that gave a return higher than government bonds even though the risk was identical. The triple-A rated MBSs were gobbled up by large pension funds at 80 to 85 basis points over “Canadas,” enabling FirstLine and its competitors to profit while undercutting the banks’ posted rates.

Mortgage brokers, newly endowed with a tremendous rate advantage by FirstLine and its growing legion of lean, non-bank competitors, quickly became a strong force in the Canadian mortgage market. Karl Straky, past president of the Canadian Institute of Mortgage Brokers and Lenders and president of the Mortgage Training Group of Windsor, Ontario believes that Calder and Wahl are responsible for mortgage brokers owning 25% of the market, from 9% in 1999 and practically nothing in 1985.

According to Straky, “the lower rates and creative products they launched in ’89 and ’90 eventually forced the banks to counterattack by selective matching, which set a downward trend for rates that just kept on going.

Given that historical reality, here’s how I come up the $50-billion. Using the banks’ most recent five-year rate (6.45%) as the starting point, I compared that with the best-quoted rates on fixed term mortgages, 5.04%, from several mortgage broker websites. I also used the difference between prime and the “adjustable rate” offered by brokers – 80-90 basis points – to average the saves to 100 basis points due to the heavier use of variable rates in latter years. I have applied this saving to 60% of all mortgages from 1995 onwards, even though it is probably higher.

FirstLine was absorbed by the banking system in 1995 as an independent unit within CIBC Mortgages, and has continued to operate successfully through mortgage brokers, recently topping $25-billion in assets. Most of the other banks have also found ways to harness the growing market power of brokers, through well-selected investments in mortgage banks with non-traditional, but effective approaches.

The legacy of Messrs. Calder and Wahl will continue. The next revolution in mortgages is upon us, as the more accessible “Canada Mortgage Bond” promises to put the power of the MBS into the hands of smaller and more nimble lenders. More to come on this in future columns.

Tony Humble, a financial consultant, has spent 26 years in banking and mortgages and was the mortgage columnist for the Financial Post from 1991 to 1999.