Using MBS as high quality liquid assets

During times of financial crisis, utilizing Mortgage-Back Securities (MBS) as High-Quality Liquid Assets (HQLA) can ensure quick access to liquidity for credit unions, regardless of regulatory requirements. MBS allow for a higher yield than other forms of HQLA.

Since our recent article Leveraging securitization during COVID-19 generated significant interest from credit unions with excess liquidity, we'd like to shed more light on using Mortgage-Backed Securities (MBS) as High Quality Liquid Assets (HQLA).

Why you should care

  • With the changes to the Mandatory Liquidity Pool (MLP) under C1, many Ontario and BC credit unions are looking into managing their own HQLA portfolios and how to use MBS, including MBS they issue themselves. Additionally, we're seeing an increased use of holding MBS as HQLA nationwide. 
  • Financial institutions are looking for additional yield at a time when margins are compressed. This strategy allows for some enhancement to the yield in the HQLA portfolio, which helps to combat margin compression.
  • While liquidity levels are high, so is uncertainty as to how or when liquidity may run off. Using MBS as HQLA is a useful tool to ensure quick access to liquidity, regardless of regulatory requirements.

How does it work?

Level 1 HQLA status

National Housing Act Mortgage-Backed Securities (NHA MBS), regardless of the Issuer, are considered a Level 1 Asset (OSFI). The NHA MBS program is a government-sponsored program and receives the full backing of the federal government. Therefore, NHA MBS benefit from the government's credit rating regardless of issuer, as all NHA MBS issued bear a rating of AAA. This gives MBS with HQLA Level 1 status.

High-level approach

To meet the Liquidity Coverage Ratio (LCR) requirement, OSFI-regulated entities often issue or acquire NHA MBS to hold on balance sheet as a portion of the overall HQLA asset mix. It is industry standard for OSFI-regulated entities to issue and hold their own NHA MBS, as the yield on these securities is the underlying yield of the mortgages, rather than the coupon of the MBS. This allows for an additional outlet for issuances, while boosting the overall HQLA portfolio yield. Issuers holding their own MBS as one piece of a diversified HQLA portfolio, balanced with other third-party MBS as well as other Level 1 Assets (Government of Canada Bonds, provincial bonds, etc.), is often beneficial and has been widely adopted. We're seeing more credit unions take note of this approach.

What are the benefits?

Access to liquidity outside of the credit union system during market events

Throughout the 2008 financial crisis as well as the market panic we observed early last year, the CMHC Securitization program remained an area of strength and a significant source of liquidity. For credit unions, liquidity generated from CMHC securitization is one of the few areas in which they can gain access to the larger market. This alleviates stress on the credit union system and provides a more robust liquidity management strategy.  

Significant support from CMHC and the federal government during times of crisis

In both the 2008 Financial Crisis and the COVID-19 crisis last spring, the Bank of Canada used the CMHC programs as a way to inject further liquidity into the banking sector through the Insured Mortgage Purchase Program (IMPP) as well as through weekly CMB purchases. Although the Bank of Canada rolled out numerous other liquidity programs last spring (e.g., bond buyback, Standing Term Liquidity Facility), most of these apply to the centrals, whereas the CMHC Securitization liquidity programs offer direct access for credit unions.

Outlet for credit union MBS

The practice of issuing MBS and holding it on book provides another outlet and diversified use for a credit union's securitization activity. This practice allows for a credit union to hold pools on book and sell at a future date that is advantageous to them, or when liquidity is needed.

Hold MBS on books and earn a higher rate

Holding MBS as HQLA allows for higher yield in comparison to other types of HQLA because the yield earned on an issuer's own MBS held on book is the average rate of the underlying mortgages, less the fees required to create the pool. Essentially, through the process of securitization, the issuer has allocated a portion of their residential portfolio to the HQLA portfolio, as it is pooled and ready to be sold to market.

Assuming a five-year mortgage rate of 1.70%, less fees of approximately 20 - 23 bps, yield on a five-year MBS issued and held on book by a credit union would be approximately 1.47 – 1.50%. This yield is approximately 65 bps higher than third-party MBS (yield of 0.836%) and 0.80% higher than five-year GOC bonds (yield of 0.675%) (pricing as of February 23, 2021).

How to get involved

Management of an HQLA portfolio has many considerations; the practice of using MBS as HQLA is no different. Although MBS as HQLA is a common strategy, it is often one piece of a diversified HQLA portfolio. Our team works with credit unions across Canada to explore this strategy and find a solution that best suits their needs. If this is something your credit union is considering, we encourage you to reach out to our team to discuss a customized approach.  

This solution provides an outlet for credit union NHA MBS while also providing additional yield. To get involved, credit unions need to be an approved issuer in the CMHC programs and have a custodial account. Our team would be happy to assist with these requirements as well.

Contact us
If you have questions about securitization or would just like to chat, please reach out to me, or any member of the team.