China's "Ghost Collateral" Arrives In Canada, "Heralding A Crisis"

Two weeks ago, a key China-linked concern that made headlines back in 2013 and 2014 reemerged after an extensive analysis by Reuters reporter Engen Tham found that China's "ghost collateral" problem, or collateral that was either rehypothecated between two or more loans, or simply did not exist, had not only not gone away but was still as prevalent as ever if not worse.

The report, a continuation of extensive reporting conducted on this site, said that 60% of all loans issued in China’s system are backed by property, and that China’s property values are “wildly misleading, which is part of the reason that China’s credit rating was recently downgraded." Reuters reported that Chinese lenders are prone to fraud with loan officers turning a blind eye to the quality of collateral and knowingly accepting dubious and even fraudulent documents.

Now, in a follow up by the Vancouver Sun's Sam Cooper, the real estate reporter explains that China's "ghost collateral" problem has jumped across the Pacific and is threatening the Canadian banking system.

As Cooper notes, "as a result of the flood of money pouring from Mainland China into Vancouver real estate in recent years, some financial experts say they believe Canadian banks are directly exposed to shadow lending in China and the risks of so-called “ghost collateral”, collateral that may not exist or is used continuously to secure loans for multiple borrowers."

And the stunner: "Postmedia confirmed that Canadian banks are allowed by the federal regulator, the Office of the Superintendent of Financial Institutions, to accept collateral from China to secure real estate mortgages in B.C."

“OSFI does not dictate what type of collateral (federally regulated banks) can accept,” spokeswoman Annik Faucher said. “Whether the borrower is foreign or domestic, OSFI (allows) financial institutions to compete effectively and take reasonable risks.”

The underlying reason for Canada's growing, if paradoxical, exposure to Chinese collateral is due to an explosion of Canada's shadow banking system. An investigation by Cooper found "massive and risky home loans are increasing in number across Metro Vancouver, while mortgage fraud cases are also on the rise, connected to the growth of so-called “shadow banking." This is similar, if smaller in scale, to the gargantuan $8.5 trillion shadow banking market in China, where "shadow" lenders and creditors bypass conventional banks to provide and obtain funding, often at far higher terms than prevailing rates, an increasingly dangerous proposition at a time when Chinese interest rates, especially on the short-end, are suddenly spiking.

The Vancouver Sun adds that as a result of tighter federal lending rules, borrowers trying to buy million-dollar-plus properties in Vancouver’s market "are increasingly taking out dangerous loans from shadow bankers in a fast-growing and poorly regulated financial market."

The trend of increasingly risky loans underlying Metro Vancouver’s high home prices is illustrated by Bank of Canada figures that show the rapid growth since 2014 of large mortgages made to people with relatively low incomes.

Cooper adds that there is also evidence of growing links between shadow banks and traditional banks, according to the Bank of Canada’s June 2017 report, as people borrow large amounts from shadow lenders to use as down payments in order to qualify for lower-interest loans from federally regulated banks.

According to a December 2016 Bank of Canada report, shadow lenders now account for $1.1 trillion in debt — about half as much as the traditional banking sector — and that over the past decade “these new players have become more important and have changed the face of the Canadian mortgage market … (as) tightening bank regulation can lead to migration of activity from the traditional banking sector to the shadow banking sector.”

Just like in China, Canada's shadow lenders are non-bank lenders that boost the supply of credit in Canada’s financial system without facing bank regulation or oversight. "Critics say shadow banking is vulnerable to loose lending standards, mortgage fraud, money laundering, and collateral that is overly leveraged (also called re-hypothecated) — meaning debt backed by property assets is used over and over again by related lenders to issue more home loans, in ever riskier chains of debt."

Among the various shadow lender groups identified by Postmedia include mortgage investment corporations, hedge funds, and private lenders such as realtors, crowdfunding companies, real estate lawyers and mortgage brokers. In other words, virtually anyone who is sitting on cash and want to generate a higher return than offered by the bank, is looking for a way to make this capital available to Canadian home buyers, in the process sending local real estate prices even higher and making Canada's housing bubble even more acute.

Some examples.

As Cooper explains, shadow lending can be as simple as a mortgage loan provided by one person to another in need of financing, or as Byzantine as the complex processes through which credit is created and exchanged and repackaged between various lenders to fund mortgages.

For example, the director of a Surrey lumber and real estate investment company explained to Postmedia that his group’s business model consists of pooling the real estate assets of an extended group of family and shareholders, and using these homes as collateral to borrow money from financial institutions. The borrowed capital is then issued in mortgages to home buyers that can’t obtain financing from chartered banks.


In another example researched by Postmedia, lending documents show that controversial “crowdfunding” developers are using single-family homes owned by investors in Vancouver to secure loans from subprime lenders that are active in B.C. in order to fund condo developments in Vancouver and Burnaby.

Quoted by Cooper, Hilliard MacBeth, an Alberta-based author and wealth manager, said that the Bank of Canada loan risk statistics and the related growth of shadow banking in Vancouver and Toronto "heralds a crisis."

“These properties in Vancouver are so expensive that you need people either laundering money or loan fraud or people borrowing such large amounts of money that should never be allowed, in order to keep it going,” MacBeth said. “If everyone is reporting their incomes honestly in Vancouver, there is no way that housing prices can stay where they are.” And yet, as we showed in early June, the world's biggest real estate bubble, Vancouver home prices, just hit new all time highs despite last year's 15% property tax targeting foreign buyers, an attempt to rein in the market.

One of the side-effects of exploding shadow banking is a spike in mortgage fraud. Postmedia’s review of enforcement hearings by British Columbia's regulator, Financial Institutions Commission, shows an increase in the number of alleged mortgage fraud cases in B.C., mostly linked to private mortgage lenders and mortgage brokers.

“We have experienced an increase in mortgage broker complaints in the last few years,” Chris Carter, acting registrar of mortgage brokers, confirmed. “About a third of our investigations relate to application fraud.”

Meanwhile, the abundance of easy "shadow" credit means that as real estate prices have exploded, even the Bank of Canada has been warning of two key risks in Canada’s housing market.

The first is that property prices and household debt have reached such extremes in Vancouver and Toronto, that “just about anything” could trigger a correction, Poloz said last week. Highly indebted borrowers could be forced to sell in a correction, the Bank of Canada says, leading to further selling, tighter lending, and a potential domino effect on banks and shadow banks.


The other elevated risk is the potential for a shock from China’s volatile economy. China has its own shadow banking problems, the Bank of Canada says.

This is where the China connection emerges: in China, “linkages between the banking and shadow banking systems are also becoming more complex and opaque, increasing the underlying credit risk,” the Bank of Canada’s December 2016 risk report says. “The experience of the 2007-09 global financial crisis showed that financial stability can be threatened by vulnerabilities originating in the shadow banking sector.”

As noted above, due to influx of money pouring from China into Vancouver real estate in recent years in an attempt to evade exposure to the local banking system, and bypass China's capital controls, Canadian banks have become directly exposed to shadow lending in China and the risks of so-called “ghost collateral.”

Cooper quoted a U.S. hedge fund manager who said that “we all know that the ghost collateral is a huge deal, and we all know that the shadow banking and other Chinese influence in Vancouver is profound. The issue is that the ghost collateral ends up re-hypothecated and laundered. So by the time it shows up in Vancouver, it will likely just look like a rich Chinese cash buyer with a suitcase of money.“

The question, of course, is what "collateral" was used to create this suitcase of money, and whether it even exists.

Cooper then shows how high risk loans in Metro Vancouver have spread in recent years, as shown in Bank of Canada maps that show where new ‘high-ratio’ loans - those where the buyer makes less than a 20% down payment on a home purchase and borrows the rest — have been issued.

If the value of the loan is 450% of annual income or more, the borrower is considered particularly vulnerable. The Bank of Canada will not reveal the number of high-ratio loans issued in Metro Vancouver, but says they are concerned with the rapid growth in these loans. In 2014, across Metro Vancouver, 31 per cent of new high-ratio mortgages were at least 450 per cent of the borrower’s income. In the second half of 2015, this figure rose to 37 per cent. By late 2016, it was 39 per cent.

Confirming the dramatic impact of shadow loans on the Vancouver market, the Bank of Canada has said that under the new tighter federal rules, roughly 43% of the high-ratio loans issued in Vancouver between September 2015 and September 2016 would have been rejected. This means either that an increasing portion of buyers in Metro Vancouver will be unable to get loans in the future or that the shadow lenders will fill the void.

For now, courtesy of the nearly $20 trillion in excess liquidity created by central banks, it's the latter however that may soon chance as central banks start to contract their balance sheets.

To be sure, the warnings are there. Ben Rabidoux, a Canadian real-estate analyst and Zero Hedge contributor, has said that his research with on-the-ground mortgage brokers suggests that loan fraud is a systemic concern in Ontario and B.C.

“The shadow market is absolutely booming,” Rabidoux said. “Of course B.C. has a mortgage fraud problem, but you won’t really see it until there is a problem with collateral in the system.”

For now, most Chinese collateral problems as we explained recently, have been swept under the rug with the express blessings of Beijing, which is desperate to prevent the re-emergence of fears about the domestic financial system and avoid further capital outflows.

What is one possible catalyst that may expose that China's "collateral emperor" is not only naked but a ghost? Global, coordinated central bank tightening of liquidity, i.e., the Fed's balance sheet unwind followed by the ECB and BOJ. At that moment, China's "ghost collateral" problems will come back with a vengeance, only this time they will also have a direct - and dire - impact on Canada's economy, unless urgent measures are taken by local regulators and government, both of which however realize that any aggressive attempts to rein in Canada's breathtaking home price appreciation could lead to an even more acute financial crisis. As a result, regulators, banks and officials will likely remain paralyzed even as Canada's "shadow market" grows and until something finally snaps, by which point it will be too late to prevent the "crisis."


pitz skbull44 Sun, 06/18/2017 - 20:38 Permalink

The Government of Canada guarantees ~$900B of subprime mortgages through the CMHC subprime mortgage insurance program and/or re-insurance of 3rd parties through the CMHC/NHA. If you use the traditional 1:10 ratio between Canada and the USA, this would be like the US government guaranteeing $9T of US subprime mortgages. 

In reply to by skbull44

Déjà view pitz Sun, 06/18/2017 - 21:56 Permalink

Hop Sing claims there'$ gold in Three Gorges Dam $pillway$...
New Ponderosa... no other third world nation...

Before you extoll Canesestan trade surplus-AGAIN...
Looking at BIG PICTURE...Canesestan ranked 197/199 nearly dead last concerning CURRENT ACCOUNT DEFICIT...which includes your so called trade surplus...

In reply to by pitz

Laowei Gweilo Déjà view Mon, 06/19/2017 - 00:14 Permalink

what's the point of that map? all it shows is mortgage value to income.... which is irrelevant because such a large portion of people buying Vancouver real estate either- get their income from China and have no income here- are retired and have no income- rely on the 'bank of mom and dad' and therefore don't rely on their own income it shows nothing about the rate of growth of low down payment loans.... it could be 5 or 5,000 mortgages per map segment it shows nothing in that regard  it's a good article .... just saying that map is irrevelent lol other than to illustrate that most people buying VAN real estate don't rely on their own income lol but it shows nothing about downpayment size rates or growth

In reply to by Déjà view

Justin Case pitz Sun, 06/18/2017 - 22:59 Permalink

in merica they call it Fannie Mae and Freddie Mac. Ben Bernanke stated in support: "I strongly endorse both the decision by FHFA Director Lockhart to place Fannie Mae and Freddie Mac into conservatorship and the actions taken by Treasury Secretary Paulson to ensure the financial soundness of those two companies. CMHCDespite the prospect of steep losses in its insurance business in the wake of a sever and unexpected economic shock, the federal agency said the results of its stress testing show that it holds enough capital to keep operating, even under dire circumstances.The Office of the Superintendent of Financial Institutions, the federal financial regulator, sets the minimum amount of capital that lenders and insurers are require to hold to withstand a severe hit to their business. Insurance companies such as CMHC are required to stop writing new insurance business if their capital ratio falls below 100 per cent of required minimum level set by OSFI. They become insolvent if their capital levels hit zero.CMHC’s stress tests show it would suffer the most dramatic losses in the event of a severe and prolonged global economic depression that sent unemployment soaring to 13.5 per cent and triggered a 25-per-cent drop in national house prices. In that case, CMHC said its mortgage-insurance business could lose more than $3.1-billion over five years.

In reply to by pitz

pitz Justin Case Sun, 06/18/2017 - 23:03 Permalink

Its even worse than Fannie/Freddie.  At least Fannie/Freddie never deviated from their requirement of 20% down during the housing bubble, and combined, were only $5-$6T entities (CMHC is ~$900B, or $9T if you use a 1:10 equivalency).  The CMHC, for a while, was writing subprime mortgage insurance at 0% down, 40 year amortizations.  As for the CMHC's claims, they have about as much credibility as the Iraqi "Minister of Informations" claims during Gulf War Part 2.  A $900B subprime mortgage guarantee portfolio like CMHC's will lose a lot more than $3.1B during a 25% drop in nationwide house prices easily.  Classic misinformation, thats for sure.

In reply to by Justin Case

Dragon HAwk Sun, 06/18/2017 - 19:59 Permalink

laundering money by buying a million dollar house, assumes you have a buyer for the House, which you will if you know who you want to move the money to.  Stealing money and getting it out of the country and parking it in Real Estate, is fine as long as you can pay the taxes, and nobody comes knocking saying we are going to take this house and prosecute you for the theft in our home country.  If you are buying a million dollar house with the family fortune thinking you are going to turn it into a million and a half you are a fool.

pitz Dragon HAwk Sun, 06/18/2017 - 20:24 Permalink

There's loads of other things to invest in that are Canadian.  RE is probably the single most expensive asset class in Canada at the moment.  It defies credibility to suggest that wealthy Chinese (who didn't get wealthy by paying top dollar for junk) are putting their money into the bubble when there's so much other stuff they could easily buy that is far better value.Chinese are amongst some of the best value investors and value seekers on Earth. 

In reply to by Dragon HAwk

pitz The Real Tony Sun, 06/18/2017 - 23:00 Permalink

Unlike North America and Europe, engineers and scientists generally run the show in China.  Not banksters.  Thats why they can accomplish entire completed projects in less time than it takes "us" to do an environmental impact assessment and "aboriginal consultation" (which is usually code-word for a bunch of old white lawyers stuffing their pockets at the expense of actual aboriginals, although lately I'm seeing a lot of younger white SJW lawyers being sent out to do the bidding!).

In reply to by The Real Tony

not a yahoo pitz Mon, 06/19/2017 - 04:42 Permalink

I know it is the envy speaking for the thief that got away, but by the likelihood that say most of China's banking debt is bad/unrecoverable, that's how an awful lot of 'wealthy' people there made their money. After all these bad loans are cash in the system that the 'wealthy' by definition own (when the loan was made, a corresponding cash entry was created and still exists) 

In reply to by pitz

Sudden Debt Sun, 06/18/2017 - 20:10 Permalink

Anybody saw this? “Combating Money Laundering, Terrorist Financing, and Counterfeiting Act of 2017” This act means that everybody must report all types of alternative currencies such as crypto's and other.But what if they suddenly call gold and silver also a alternative currency??And for Americans, coinbase is about the only way to buy bitcoins and they'll report all American transactions. 

pitz koan Sun, 06/18/2017 - 20:25 Permalink

Buy the Canadian stock market index funds like XIU.  Hasn't gone anywhere in 10 years and is only up ~30% in 17 years.  Eventually enthusiasm will return to the stock market, especially as the gold sector starts to perform a lot better.  Canadian big-5 banks quadrupled last time the housing market crashed in Canada as well on account of their effective 'short' positioning against housing.

In reply to by koan

Jafo Sun, 06/18/2017 - 20:06 Permalink

The "authorities" have always taken a lax view of real estate as the asset is not transportable out of their jurisdiction.  Once upon a time it was Michael Q Mouse that was the largest holder of real estate in any jurisdiction of the Anglo West.  Not any more.  Now it is Mr Michael Q Chan.  They are not worried as the asset is still there in their jurisdiction.  They should be worried because the re-hypothecation of the asset will mean that their banking system will be sucked into the black hole of the Chinese shadow banking system. Price discovery will hurt.

pitz Sun, 06/18/2017 - 20:22 Permalink

Only problem is, there's no evidence of Chinese participation in Canadian RE markets other than the trivial buy/sell or two.  Canada's RE bubble is entire explainable in the context of leverage/credit emmitted by Canadian banks.  Additionally, Chinese investment in Canada, ~$5B/year, is fully accounted for in the natural resource and GoC debt sectors.  So nice try, but Canada's RE marketplace has almost nothing to do with China in any way, shape, or form. If you want an ethnicity to blame in Canada, Indo-Canadian families are notorious for being "landlord families" where they will pac-man 20-30+ units, heavily on subprime credit, to 'create' employment when they are otherwise excluded from the traditional employment marketplace.  "Assignment flipping" was mostly south Asian ethnics flipping, on paper (but not at Land Titles, where they'd have to pay fees and taxes) properties amongst themselves to establish higher reference valuations and convince their lenders of a rosier state of affairs than really existed.   (no legitimate buyer would actually pay money for a house unless clear title was conveyed to them!)  Blaming "Chinese" is awfully convenient, but not rooted in the facts. As far as Vancouver prices between actual arms-length transactants, on identical property, they peaked in 2013.  As they did in Toronto.  Coincident with the big CMHC crackdown on subprime credit. 

CHoward Sun, 06/18/2017 - 20:49 Permalink

So if you can use a piece of property as collateral in China for a mortgage in China - I guess it doesn't matter if it actually exists or worth what some piece of paper says - just sell the home is the name of the game.  It certainly doesn't matter if the buyer can't afford the home.  Does ANY of this sound familiar?!?