CMHC in Motion: Becoming a World Leader in Housing Risk

Speaking Notes for Evan Siddall, President and Chief Executive Officer, Canada Mortgage and Housing Corporation

Northwind Professional Institute Inaugural Housing Finance Forum
Langdon Hall
Cambridge, Ontario

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It is my great honour to kick-off this inaugural Northwind Professional Institute Housing Finance Forum.

Given your agenda, you will be expecting me to offer a perfunctory review of the status of housing markets in Canada, a discussion of persistent vulnerabilities, a review of recent sandbox changes, the prospects for lender risk sharing and maybe even muse about potential future changes.

If I do that, I will be repeating what I and others have already said, and I will bore us all. You will kindly thank me and enjoy a couple of days here amidst the southern Ontario countryside.

I’m not going to do that.

Instead, I am going to pull back the drapes for you. I will give you the insights you’re seeking but I will do it via a more enduring subject: what we are doing at CMHC to become a world leader in housing risk management and why that matters to Canadians

Before I do so, I want to acknowledge three colleagues here with us who are central to CMHC’s journey.

Steve Mennill is Senior Vice-President of Insurance; I challenge anyone to match his knowledge and understanding of housing.

Our Chief Financial Officer and Senior Vice-President, Capital Markets, Wojo Zielonka, also has a sophisticated grasp of risk and the unrelenting courage to challenge us to do better.

And finally, our progress in the evolution of risk management at CMHC would not have occurred without the leadership of our Chief Risk Officer, Romy Bowers, who joined us in 2015 from one of the large banks. Crucially, Romy’s leadership and deep understanding of operational risk have helped us extend a risk mentality across the enterprise. As you know, Romy has also contributed her intellect and energy as part of this event’s organizing committee.

CMHC as an instrument of public policy

CMHC is one of the most important financial institutions in Canada. Think of that classic holiday movie, It’s A Wonderful Life: we sit at the intersection of banking and people borrowing to buy their homes.

But we do so on a national scale, much more than Bedford Falls. Managing about $1 trillion of financial activity, we are a domestically systemically important financial institution.

Our firm stance at this intersection can be powerful: in standing ready to buy $125 billion of mortgages to support lending during the global financial crisis, CMHC helped insulate Canadians from the worst.

The U.S. sub-prime crisis illuminated the importance of housing to the financial system. It didn’t take people long to notice CMHC’s role as a cornerstone of our economy.

A few commentators and some politicians worried that we were too large and mused about our privatization. This view overlooks what we have in CMHC, a unique and enviable institution by global measure.

Not only do we provide the stabilizing value of being a shock absorber, we combine our presence in mortgage lending with an assisted housing function that supports 555,000 households in need in 2016.

The breadth of our perspective on the full spectrum of housing informs our research activities and supports the policy advice we give to ministers. You see us as a Crown corporation and government sees us very much like a federal department, and the President as de facto deputy minister of housing. The Deputy Ministers of Finance and Employment and Social Development Canada are key partners in this work, and are on our Board of Directors.

Despite our importance, we risked losing our relevance. In a sense it was our own fault. We were guarded and defensive, so concerned about not rocking the boat that we had little to say. In hindsight, we had been typically Canadian: modest, and to a fault.

Understandably guarded and insular in the face of criticism, we were turned inward and risked losing our place in the world.

Any enterprise needs clarity about why it exists, and public entities must be held to an even higher standard: governments can crowd out others by their very presence.

And holding us to account isn’t simple: taxpayers can’t sell our shares nor vote out our Board. It is therefore our duty to confront the existential question of what value we provide – of why government needs to be involved. A diagnosis of CMHC’s raison d’être was needed.

Our strategic drift had been a particular problem. The company had been criticized for being driven too much by growth for its own sake, whether maximizing market share in insurance or growing our securitization volumes. Pursuit of growth caused us to add riskier insurance features such as extended mortgage amortizations. And we were unable or unwilling to prevent an erosion in our historic assisted housing activities.

So we got back to basics.

Our mission and strategy

We started by answering a few key questions. We reaffirmed a noble mission, an aspirational vision and a path to achieving them, questions any company must answer clearly.

Why do we exist; what is our mission? We help Canadian meet their housing needs. This statement expresses both a noble purpose and one that is conscientiously restrained.

Where are we going; what is our vision? We will be at the heart of a world leading housing system. Our vision properly extends beyond what’s good for CMHC to the welfare of our housing system as a whole.

And how will we serve our mission and achieve our vision; what is our strategy? We will (1) achieve better outcomes by managing risk, (2) lead through innovation and insight, and (3) be a high-performing organization – one that is admired by Canadians and is reliable and interesting.

Risk management is job one. It’s linked to everything we do. And there was work to be done.

Risk management at CMHC

A review of CMHC by the Government and the Office of the Superintendent of Financial Institutions (OSFI) had previously concluded that some wholesale changes were needed to our governance, oversight and risk management capabilities.

Our initial response to OSFI’s observations was to cross items off their list of action items. We were driving by looking in the rear view mirror. We weren’t keeping up; we weren’t anticipating change. We were not truly managing our risk; in a sense, OSFI was.

That had to change. Over the past few years, we have ourselves focused on six key risk-management deficiencies, all informed by OSFI’s guidelines¹, which are based on sound risk-management practices: (1) stress testing and capital management, (2) lender quality assurance, (3) model governance, (4) our internal audit function, (5) cyber risk and, (6) crucially, our risk management policies and practices.

In our estimation, our internal audit and lender quality assurance functions are now robust. Our work in stress testing, capital management and model governance will achieve maturity in 2017. Cyber risk will be an ongoing effort, with our capabilities substantially advanced via our IT partnership with Accenture. Finally, we made important progress on an enterprise-wide approach to risk governance last year.

We had struggled to navigate between our dual mandate to support access to housing and to promote financial stability. In pure housing supply terms, more is more of the former and more is less of the latter.

While we had a governing Risk Appetite Framework (RAF), it avoided the question, using circular and euphemistic language relying on our “access” mandate as an escape clause.

We have since revised our RAF to reconcile this tension using a conditional model that navigates between different states. To summarize: we will prioritize financial stability unless and until economic dislocation occurs²; in those events, we stand ready to take a more active role in supporting Canadians’ access to housing.

The conditionality of our risk posture has clarified our decision making, including in response to OSFI’s new risk-sensitive mortgage insurance capital guidelines. As a result of our new approach, we have recently announced price increases for our transactional insurance to fully compensate us for increased capital holding levels, which have introduced credit scoring as a factor.

However, instead of increasing our pricing even more for lower credit scores, we have opted to accept lower ROEs for that business, which is less served by the private sector. Our examination of the potential socio-economic impact on rural, remote and lower valued homes caused us to price this risk differently than for higher credit scores. That said, we have signalled an intention to explore future price differentiation more based on credit scores.

For low ratio portfolio insurance, we have adopted a fully risk-based approach. This is insurance purchased by the lender months or even years after the loan is originated, for the purpose of using the loan as collateral in CMHC-sponsored securitization.

The new capital framework applies to these insured loans as well, and will result in premiums that are on average more than double the current premiums. However, there will be considerable variation depending on the risk characteristics of the loans in the portfolio. We have provided our clients with substantial detail about the range of premiums to expect given various loan-to-value ratio and credit score combinations.

Risk culture

I am proud of our progress as a risk manager. Beyond our achievements in our six focus areas, instilling a risk mentality in all that we do will make us a world leader.

Risk management is a way of thinking; it reflects an attitude about risk. An effective risk manager imagines what could change in order to prepare for it. She also imagines what should change – and bends the world to make it happen.

In 2014, the Financial Stability Board (FSB) published a guiding paper on risk culture for regulators³. The FSB outlined the foundational elements needed and identified four indicators of a sound risk culture: tone from the top, accountability, effective communication and challenge, and incentives. These four indicators have been central to the changes we are undergoing at CMHC.

My colleague Jeremy Rudin, Superintendent of OSFI, also addressed the importance of culture in risk management in a speech to the CD Howe Institute in 2015.⁴ Beyond rules and checklists, the Superintendent underscored the need to attend to “…norms, attitudes and behaviours related to risk awareness, risk taking and risk management and how these reinforce, or undermine, responsible risk management.”

Senior management can change strategy, structure, systems, even people – and we’ve done all of this at CMHC; however, absent addressing the prevailing influence of culture, the project is lost.

CMHC is a very different organization today, in part reflecting the energy of nearly 700 new employees over the last two years. This progress has been necessary but is not yet sufficient.

More change is needed. Our goal of being a world leader in housing risk required us to attend to our culture as well: getting at the shared history, cultural artifacts, biases and hidden “rules” that still trip us up.

We determined that being a world leader would have to come at the cost of some near-term progress. Changes would slow our advancement in order to accelerate and sustain it.

CMHC in motion

Academics and authorities have written much about what boards and management can do to support effective risk cultures. The catalyst for our evolution was in fact a professional approach to corporate governance with a sharp focus on risk management. That started in May 2013, when Bob Kelly was appointed board chair.

Keeping up with risk management means keeping up with change, even leading change. So we initiated a multi-year program of change for CMHC in September 2014, with risk management at the core. What we call CMHC in motion has four pillars:

• Focused role: Our mission statement, which explains the “why” of what we do, is a yardstick to identify the risks and opportunities we should embrace versus those we should avoid or outsource. Early on, therefore, we eliminated programs that did not need government support, such as mortgage insurance for condominium construction and for second homes. This same thinking caused us to target a more modest market share of 40 to 50 per cent and also gave birth to the idea of lender risk sharing.
• Accountable culture: We want to unleash the collective wisdom of our 1,900 colleagues. So we initiated extensive leadership development training and changed our performance management and reward systems, adding incentives in place of entitlements. We extended decision making throughout the organization, placing risk management closer to the risks, supported by “three lines of defence.” Risk is now everyone’s business. Importantly, this includes giving people permission to challenge one another; the “price of being nice” has proven to be too high.
• Efficient processes: We have sped decision making and flattened our hierarchy by removing three management layers. That involved a culturally challenging reorganization that saw 565 colleagues placed in redefined roles and 240 employees depart. In doing so, we created the capacity to add 55 new risk-management positions throughout the enterprise. Finally, plagued by years of under-investment in technology, we have formed a multi-year partnership with Accenture to boost our efficiency by moving our technology to the cloud, rationalizing our applications portfolio by 75 per cent, further re-engineering our processes and launching a transformative digital strategy.
• Enabled people: We are delivering on this last pillar by freeing the housing experts at CMHC to do their jobs and manage risk. For us this is the holy grail of risk management and becoming a world leader in housing risk management. Our next task at CMHC is to embed innovation in our culture: to move from a culture that seeks perfection to one where failures are viewed as opportunities for progress, rather than as steps backward – from a culture of avoiding risk to one where particular risks are embraced.

Results so far

We believe that you get what you measure, and we measure our risk culture.

Our most recent risk-culture survey was completed in December. After an improved response rate among our employees, almost all cited a good understanding of our risks (92 per cent) and how we manage them (93 per cent). And 88 per cent believe senior management promotes and maintains a culture that values the importance of effective risk management, up from 71 per cent two years ago.

I have explicitly or implicitly mentioned our progress regarding the FSB’s four indicators of risk culture. On top of these, we have deliberately targeted improved transparency, consistent execution, conscious innovation and diversity of thought in order to fortify our risk culture.

Transparency

As a public entity, CMHC has a duty to seek the best ideas and information – the truest truth – even if that comes from outside. Where our posture had been closed in the past, we now see openness as a form of risk management: both by engaging with our employees and by crowdsourcing better ideas.

Information diffusion is a key tactic in recruiting better ideas to our risk management. We said when we first published our annual stress testing results that we should be open to new ideas and critiques of our analyses. If CMHC has improved its risk management by enabling 1,900 employee decision makers, we know our housing system will be even more resilient with analysis and ideas from thousands of thinkers.

You have also seen us be more proactive about our assessments of housing markets in Canada, the last of which we issued this past Monday, even daring to issue a red flag on the country as a whole last October.

While mortgages continue to perform well, we still worry about the impact on consumption and economic growth of excessive mortgage activity. Rapidly escalating house prices are also cause for concern, particularly in the Toronto and Vancouver markets.

Consistent Execution

Our work starts with our clients: lenders, non-profit community housing providers and co-operatives, and Indigenous communities. Our ability to manage the risks we assume for them requires more consistently delivering on their expectations of us. This means fulfilling our promises, setting targets and meeting them.

Consistent execution extends to our role as a policy advisor to government; in this sense, to serve Canadians.

Early on, we set out to strengthen our policy team and our relationships with our federal, provincial and territorial counterparts. The product of this work includes market-level pricing for all of our commercial products, two rounds of changes to the mortgage insurance parameters and a re-assessment of the roles of lenders and insurers via a risk-sharing framework.

And soon, the Government will propose a National Housing Strategy, the development of which CMHC has led in concert with provinces and territories.

Conscious Innovation & Technology

An emphasis on conscious innovation was the theme of an enterprise-wide conversation last year. We need to confront those seven expensive words: “We have always done it that way.”

Innovation had been seen as taboo in our legacy culture of risk-aversion; our maturing risk culture brings new ideas to our strategy, to how we confront risk at every level in the organization. Our technology transformation will also support innovation and the cultural transformation necessary to support it.

One of our stated values is to “Ask ‘why?’” and to question established norms. We see this is a critical defence to the dangerous and all-too-common groupthink we’ve adopted in the past. It is an essential practice to confronting risk at every level in the organization. So more than enabling our employees to ask “why,” we expect it.

Diversity

Finally, diversity is a strength and a virtue; it is a crucial tool in fortifying our risk culture.

I don’t mean tokenism. I mean diversity writ large: a multiplicity of ideas and perspectives. Creativity and innovation, the means by which we tackle risks and make decisions, emerge from diversity of thought and experience.

CMHC has been repeatedly celebrated as one of Canada’s Best Diversity Employers. We aim for a workplace where everyone feels welcome – embraced even – where tolerance of and respect for all people must be non-negotiable.

We see diversity from diverse angles. Canada is the product of many ethnicities and two official languages. Diversity of gender is our starting place: we have set a target in our Corporate Plan of 54 per cent women (our current employee ratio) in leadership positions within two years. We also have targets for visible minorities, persons with disabilities and Indigenous people.

A housing strategy for Canada

Housing has come a long way: our early ancestors saw shelter as a basic human need and little more. Indeed, CMHC was created for this purpose: to house veterans returning home from World War II.

More recently, since the 2008-2009 financial crisis, we have seen housing as linked to the systemic nature of our financial infrastructure. Inherent linkages between banking and housing via mortgage financing and securitization funding can act as pro-cyclical transmission vehicles for risk.

Even more important, however, we now see housing as linked to economic growth.⁵ Housing is like blood pressure for an economy: we need some, but not too much.

Price levels and low interest rates have encouraged speculative activity. Housing boom and bust cycles frequently precede financial crises as housing affordability pressures cause homeowners to reduce spending, which drags our economy down.

Accordingly, the Finance Minister acted last October to contain the scope of mortgage insurance and to rein in potential tax abuse by both domestic and foreign investors. An increase in housing supply would also help dampen price growth and support affordability.

CMHC’s re-emergence has been opportune. The past year was a threshold year for us: with our Department of Finance colleagues, we advanced both the important mortgage insurance parameter changes and lender risk sharing to strengthen our housing system through-the-cycle.

And Canada’s first National Housing Strategy in 40 years promises to wield housing policy as a powerful tool to improve our economic prospects and even more: to strengthen our social fabric. We now see housing as an ingredient in promoting social inclusion, tolerance and those unique attributes that make us so wonderfully Canadian.

Conclusion: Towards leadership in housing risk

I want to conclude with our values. Culture emerges from the behaviours you choose to reinforce. The building blocks for CMHC’s culture are the values we share as colleagues.

In 2015, we engaged in a company-wide exploration of what we care about. Our stated values include some non-negotiables and reinforce some deeper messages about being responsible and purposeful.⁶ Notably, they also signal innovation, inquiry and supportive challenge. They are clear and simple: an enabling manifesto, not a checklist.

Our first value is to “Be an owner.” Ownership implies stewardship and sustainability, a responsibility beyond the transient status of being a passing, part-time “renter.” Owners naturally identify, measure and embrace risk; they ask questions and innovate.

Our culture and the idea of owning risk comprise the fuel for excellence in risk management and our goal of being a world leader in housing risk management.

Canadians deserve no less from us. Thank you.

¹ OSFI issues standards for residential mortgage insurance underwriting, known as the B-21 Guideline, as well as a Corporate Governance Guideline for federally regulated financial institutions.

² “Economic dislocation” is meant as a catch-all phrase for a series of specific triggers, all generally in the category of “market failures.” When housing markets are not functioning in an orderly or regular way, we may then choose to assume more risk so as to support access to housing.

³ Financial Stability Board, 2014. Guidance on Supervisory Interaction with Financial Institutions on Risk Culture: A Framework for Assessing Risk Culture.

⁴ Jeremy Rudin, 2015. “Away from the Lamppost: Culture, Conduct and the Effectiveness of Prudential Regulation,” (speech to the C.D. Howe Institute, 17 June 2015).

⁵ Evan Siddall, 2016. “Housing in Canada and the Imaginary City: Addressing Vulnerabilities, Data Gaps and Affordability,” (speech to the Greater Vancouver Board of Trade, 30 November 2016).

⁶ CMHC’s values are: Be an owner. Amaze our clients. Think “yes” first. Do the right thing. Believe in each other: we are better together. Celebrate both wins and failures. Ask “why?” Be fearless in the face of change. Make a difference. Have fun every day.