If mortgage loans are ships at sea, they are locked on a course that’s taking them directly into a storm. Reports released since COVID-19 hit the Canadian economy tell us that that storm – a nauseating combination of rising mortgage defaults and crashing real estate prices – is coming.
This knowledge leaves mortgage lenders with three questions: What should they do to prepare? How should they navigate the situation? And will their investments survive?
Early warnings of mortgage defaults arrived shortly after COVID-19. In April, a Dart & Maru/Blue survey found that one in 10 Canadian mortgage holders believed they would soon default. A majority of Canadians also believed that housing prices would depreciate in the months to come.
In May, CMHC CEO Evan Siddall warned the country that a growing debt “deferral cliff” is looming in the fall, when borrowers will have to start paying their mortgages again after a six-month respite. When the deferred debt comes due, as much as 20% of mortgages could be in arrears. Soon after, the Bank of Canada echoed Siddall’s warning in a financial system review released on May 26.
The risk of default is compounded by falling real estate prices. According to the experts, Canadian housing prices are set to fall by between 9% and 18%. A full return to pre-COVID levels is not expected before the end of 2022.
Thanks to two decades of low unemployment and rising real estate values, many private lenders have never experienced a default. If they have, the borrower has typically been able to remedy the default or refinance the mortgage loan before enforcement became necessary.
Mortgage lenders can take practical steps to protect their loan investments before they are lost at sea. While no amount of planning can guarantee that a determined borrower will not bring endless motions or break the locks to re-enter the property, lenders can mitigate much of the risk related to mortgage enforcement through preparation.
First, assess the likelihood that the borrower will default on the loan. Gather all available information about the borrower from the mortgage application, publicly available documents and even from the borrower themselves. If a borrower has lost a job or had to shut down a business, the lender needs to know. For corporate borrowers, obtain an updated corporation profile report to see if the corporation has been dissolved. If it has, the land securing its mortgage loan may become vested in the Crown, and the lender will face a special set of challenges.
Second, determine whether the security sufficiently ensures repayment of the loan. Factors will include an assessment of the current value of the property, the position the mortgage is in, whether the property generates income, whether an assignment of rents was provided and whether any personal guarantees were given. A lender that is not in first position should consider how much equity might be available if the property is sold and what it will do if there is a shortfall. Second and subsequent mortgagees might also wish to consider whether they have or can get enough capital to pay out prior mortgage lenders to get control of the mortgage enforcement process.
Third, work with knowledgeable legal counsel to develop a mortgage enforcement strategy. Several remedies are available; there’s no simple answer to the question of which one will be most effective. In every case, the lender must weigh the merits of all available remedies with the help of experienced legal counsel.
As housing prices fall, distressed borrowers will have limited ability to refinance a mortgage in default. Some highly leveraged borrowers will choose to walk away from real estate investments once their equity dwindles down to nothing. Compared to recent decades, we can expect more contested proceedings and difficult choices about the best remedy.
The good news is that mortgage lenders can improve the odds of reaching safe harbour with strategic preparation and sound advice. The storm is coming. The time to prepare is already here.
Michael McWilliams is a partner and head of the commercial litigation group at TK law firm Loopstra Nixon. Tamara Watson is a student-at-law at Loopstra Nixon who will be called to the bar in 2020.