Factory-LendingSome of the new mortgage policies decreed by Ottawa are bad for credit unions and their customers.

That’s the gist of this report recently issued by Canada’s credit union system.

Among other things, the Credit Union Central of Canada (CUCC) says the federal government’s rules promote “commoditization” of mortgages and fail to allow for low-risk lending that falls outside of regulators’ defined guidelines. The paper—one of the more publicly critical essays on federal mortgage regulations—suggests Ottawa’s rules essentially result in “factory lending.”

CUCC floats some compelling ideas on a wide swath of mortgage topics. These are the highlights (our comments in italics):

On the Impact to CUs and their customers:

  • Increasing regulatory oversight “could be construed as furthering the commoditization of loan products and undermining long-standing credit union practices of lending based at least in part on character, membership in a community, or other intangible or ‘soft information’.”
  • “…The federal government’s policy direction poses a risk to the credit union system to the extent that it favours factory lending.”

On the downside of commoditization:

  • factory-mortgagesFederal lending rules could “impinge on the ability of credit unions to lend to anyone who is asset rich and income poor, but otherwise represents a very low default risk.
  • These “asset rich, income poor” individuals include many wealthy seniors, high-income recently divorced couples whose income and assets are tied up in legal proceedings and the temporary startup costs of operating two households instead of one, and small business owners who are able to legally shelter much or all of their income from a tax perspective but who nevertheless are perfectly able to service substantial home mortgage loans.”

On research supporting CU lending practices:

  • “…The Bank of Canada has produced research that shows how [limiting flexible discretionary underwriting] could also increase default, and hence systemic risk.”
  • “In the study, the authors find that Canadian banks which rely on hard information – essentially quantifiable metrics such as credit scores, gross debt service ratios and total debt service ratios – at the expense of soft information (assessments of character, family, community) tend to incur higher default rates than those that use more soft information.”
    (This also explains why some non-prime lenders have been known to have lower loss rates than some prime lenders.)
  • “In fact, the study shows that a (standard deviation) greater reliance on hard information is associated with a 10 per cent increase in bankruptcies.”
  • “These are important findings that should be understood by all policymakers before they reflexively increase regulatory burden, effectively commoditize lending products and indirectly undermine what has traditionally been an important credit union advantage.”
    (Despite a large degree of prudent rule-making, there has likely never been a greater preponderance of knee-jerk mortgage regulation than in 2012.)

On the reasons for commoditization:

  • “…Commoditization allows for quantification and it is often said that you cannot control what you cannot measure.”
  • Regulatory tightening “facilitates…the federal government shedding responsibility for insuring mortgages, a little understood outcome that recently received some attention after federal finance Minister Jim Flaherty mused publicly about the possibility.”
    (This is a relatively new twist on the motivations behind Ottawa’s new mortgage regulations.)
  • “Commoditization, or ‘factory lending’…allows regulators to easily monitor and exert some control over the financial services sector from the comfort of their desks, an important consideration in an era of fiscal restraint and ongoing human resource challenges at regulatory bodies such as OSFI.”

On provincial adoption of federal mortgage rules:

  • regulations-mortgage“…The policy distance” between federal and provincial mortgage regulation (among other types of financial regulation) “is likely to narrow substantially in the future.” But, “any narrowing of this gap will take time, if it happens at all.”
  • “…The federal government has made it clear to provincial governments that it will not backstop them in the event of a crisis at a major provincially-regulated financial institution.” (Yet Ottawa would love provincial lenders to follow its rules.)
  • The feds may use “moral suasion” to get provincial bodies on board with its mortgage regulations.
  • “OSFI cannot (directly) impose the guideline (B-20) on provincially-regulated credit unions” but “two major provincial regulators are already encouraging credit unions to follow the B-20 guideline.”
  • “…The Deposit Insurance Corporation of Ontario (DICO) and the Financial Institutions Commission in British Columbia (FICOM) ‘have asked member institutions to closely follow the recently introduced OSFI guidelines around residential mortgage lending…’ That’s according to CUCC’s ‘discussions with chief executive officers at two large credit unions’ as well as ‘a conversation with a senior provincial official’.”
    (Yet, overall, there have generally been few visible changes in credit union lending guidelines.)
  • CMHC’s approved lender designation allows “the federal government to directly influence residential underwriting practices at credit unions…Discussions with CMHC officials confirm that the Crown institution is considering how it might integrate elements of the B-20 guideline into these criteria.”  (It appears this is a back door that Ottawa can potentially use to force B-20 down the throats of CUs.)

On portfolio insurance:

  • “…If there is a mortgage product that can and should be commoditized…very safe, plain-vanilla (low-ratio) mortgages are probably it.” Such mortgages were widely insured using portfolio (a.k.a. “bulk”) insurance until CMHC cut back on it earlier this year. That subsequently led to liquidity concerns and product elimination at a variety of small lenders.

On privatizing CMHC:

  • CMHCPrivatization of CMHC “likely will not [happen] anytime soon.”
  • Flaherty’s hints about it “are at best medium to long-term plans contingent on electoral cycles and thus highly susceptible to being derailed.”

On covered bonds:

  • The credit union system should “work together to consider what a credit union covered bond issue might look like.”  (Covered bonds were a fast-growing source of mortgage liquidity before the feds clamped down on them earlier this year. Currently, only a handful of lenders can issue them.)

On the possible response from credit unions:

  • “…From a lobbying perspective, the system might wish to direct Canadian Central to argue the case for carving out space for credit unions that want to behave a little differently than their bank competitors. In practical terms, this could mean some kind of proportionality test and/or limited exemptions to the general rules for credit unions that want to avoid the commodification trend and focus on old-fashioned relationship banking.”

Rob McLister, CMT

  1. Things are bottlenecking aren’t they?
    As funding sources tighten there’s a possibility credit lines will, first, not be offered as freely and then existing lines being called in.

  2. Maybe it’s time to think about amending the Bank Act to permit lenders, federally regulated or otherwise, to opt out of mandatory CMHC mortgage insurance for a select group of premium borrowers who wish to put down less than 20%.
    This could be accomplished based on criteria mandated by the lenders themselves, such as credit history, net worth etc., whereby the lender takes all of the risk if the loan falls back.
    At first such a system could have limits on the percentage of total uininsured high ratio loans that a lender is permitted to issue, with the intent of increasing that percentage over time based on loan performance / delinquencies.
    This way some of the pressure (or at least perceived pressure) is taken off of the taxpayer and placed squarely on the shoulders of lenders and their underwriters.
    If done correctly, the quality of such a loan portfolio would be very high. As such, I doubt that lenders would have any difficulty selling said mortgages as Triple A investments.
    I think we all know that CMHC will not be disappearing overnight, but a gradual approach to phasing it out, which could also include eventual privatization, is well worth considering.

  3. Backlash by the BIG BOYS has already affected credit unions. Meridian CU’s recent changes to retreating to only lending to members 15 minutes from a branch, is less about nitche marketing,(despite their wording) than a weak response to the massive push against their higher profile(by CMT and others)celebrity status in the last couple of months of not having to follow the banks in the changing of rules. Credit unions are not even a flea on the banks of the banking industry, but when they start acting like mosquitoes, they have to expect a slap down

  4. “…and small business owners who are able to legally shelter much or all of their income from a tax perspective…”
    This is one of the least talked about reasons that the feds made these rule changes, but I have a feeling they want more small business people (and their accountants) forced to declare more income and pay more tax. It’s at least partly about revenue.

  5. Another great post Rob. The fact that credit unions are not regulated by the feds are seen by many as an opportunity for sure. My experience is that credit unions have prudent risk management policies in place and only time will tell if the various provincial regulators tighten the rules that apply to them also.

  6. According to BofC stats, CU’s have about $140 billion in mortgages. Banks are $880 billion.
    CU’s are actually a solid second after the banks.
    One wonders how much more capacity CU’s have? $140 billion isn’t chump change.

  7. I applaud credit unions for taking a stand. There are so many people who don’t meet the bureaucrats’ rules but can obviously pay their mortgage. These people shouldn’t haven’t to suffer with B-lending rates.

  8. Credit unions are like mini banks but they offer more value. As their deposits and funding sources grow, so will their mortgage market share.

  9. What you said makes sense in many ways but I think the Bank Act requires high-ratio insurance to protect banks from themselves.

  10. I remember when the 0% down, 40 year amortizations came out in 2006, the federal government reassured everyone these would only be offered in “special” cases, like a new doctor, or high potential income individual with not much assets. The banks, mortgage brokers and credit unions then used this “special” program to offer jumbo-sized mortgages to every mouth-breather with a Canadian Tire credit card. The reason “hard rules” have been implemented is because lenders have used every possible loophole and connivance to defeat the spirit of those regulations. Ergo, commoditization or “factory” lending. Those who fail to self-regulate are subject to more forceful external oversight.

  11. One of the big dangers of CUs vs. Big 5 banks is lack of geographic diversification. For example Oshawa Community Credit Union can have all the “hard” and “soft” rules helping them with their underwriting… None of it will matter if GM Oshawa goes belly up or transfers half their work to Mexico. Whereas, BMO or Royal has a 0.3% hit to their mortgage book with the same event. CUs should expect tighter regulations because of their limited geographic mortgage diversification.

  12. You’re under-estimating the bond market. The lender you’re describing wouldn’t find abundant funding for non-insured high LTV business.
    This would be a niche at best.
    The saviour is US sources of $$$, not CU’s.

  13. It’s actually the complete opposite. A more defined geographic concentration helps CUs specialize in that area and know their customers. GM moving jobs would hurt Oshawa Community Credit Union but it wouldn’t be a systemic problem. In other words, it would have no effect on other CUs outside of Oshawa.

  14. Hi Tomas, This is an interesting question. I have a feeling rate comparison sites will help CUs attract mortgage clients more easily in 2013. We may also see CU’s band together a little more. That could help with everything from funding efficiencies to overall promotion. I’m not sure how much it’ll boost volumes but it certainly won’t hurt.

  15. Given that CU mortgage share has been more or less the same for years, change now would probably require a macro event (something like a US buyout?).
    What do you perceive has been the limiting factor on CUs all these years?
    I think it’s simply $$$. They havent been able to get over the hump and raise more than $150 billion. Being deposit driven only goes so far.
    Band together? If not for human nature it might happen :- )

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