(Non-traditionally) Regulated Lenders Grow

Market share FBThe Globe and Mail reports that “unregulated lenders” now own a 15% share of Canada’s mortgage market, according to a Finance Department memo it obtained. That sounds somewhat concerning as a layperson, doesn’t it?

It sounds like Canada has some drunken, unrestrained Wild West lending going on. You can hear Joe Public thinking, “These yahoos must be selling those insidious teaser rates and doling out those NINJA (no income, no job, no assets) mortgages that sunk the U.S. market in 2008.”

That’s unfortunate…because it’s not true.

Right off the bat, let’s dispense with the term “unregulated” as it applies to prime mortgage lending. It’s complete baloney (I’d rather use another term but kids might be reading).

Virtually all prime non-bank lenders are regulated. They must conform to:

  • Federal regulations that apply to the banks providing their funding
  • Federal regulations that apply to insurers providing their default insurance and securitization
  • Provincial regulations applying to mortgage brokerages, administrators, etc.

On top of this, non-deposit-taking lenders must withstand the regular audits and scrutiny of their OSFI-regulated bank funders and investors.

All told, this puts them under a microscope that’s just as intense as the major banks, if not more so. Anyone who thinks banks would risk their capital and reputation by funding them otherwise is woefully misinformed.

Note, of course, that the aforementioned regulations do not generally apply to private subprime lenders. Those lenders account for roughly 1 in 16 mortgage originations, according to CIBC (see its chart below). Yet, they present arguably no material systemic risk because they’re predominately investor- and self-funded, require higher borrower equity, and price and underwrite commensurate with their risk appetite. (Incidentally, the rise in private lending is directly attributable to policy-maker’s own actions — i.e., stricter federal lending guidelines.)

Source: CIBC, Teranet
Source: CIBC, Teranet

The Globe further reports, “The government memo estimated that about 90 per cent of the business of unregulated lenders is subject to federal mortgage rules, which include meeting the strict underwriting standards set by CMHC and the Office of the Superintendent of Financial Institutions, Canada’s banking regulator.”

The message here is that non-deposit-taking lenders have countless checks and balances and ample supervision to assure their stability. That’s vital because, as the Department of Finance is quick to point out, they’re “enhancing competition in the mortgage market.” Moreover, they account for roughly half of broker originations.

So let’s not allow news stories without context to send the wrong idea about non-traditionally regulated lenders. They and their mortgage broker partners are overwhelmingly responsible for keeping rates and prepayment penalties down, and that keeps more money in Canadians’ pockets.

  1. Excellent job Rob. This article and the previous one help to inject some sanity and much-needed reality into the analysis of the Canadian real estate market. Thank you.

    1. That’s a fair question Tomas and thank you for the post.

      First, it bears noting that Home Capital is not a non-traditionally regulated (“unregulated”) lender. They are federally regulated. Moreover, they are deposit taking (with more latitude and funding options than most monoline lenders), have always been non-prime focused and have long had a unique sales and underwriting culture (which they’ve since had to change).

      But more to your point, there is fraud at every single regulated lender, including all OSFI-supervised banks and trust companies in Canada. And there always will be.

      The issue with Home was that it’s fraud experience was widely publicized and more widespread. It was a terrible mark on our business but it was also a blessing. It put regulators on the hot seat which resulted in even stronger supervision of mortgage underwriting and more stability industry-wide.

      By the way, it’s no coincidence that OSFI announced the following last month: “Moving forward, OSFI will place an even greater emphasis on confirming that financial institutions conduct prudent mortgage underwriting, and that their internal controls and risk management practices are sound…”

      Read more here: http://www.osfi-bsif.gc.ca/Eng/fi-if/in-ai/Pages/rfmrm.aspx

      Fortunately, fraud has always had a small impact on defaults. And, despite what you may be led to believe, that impact will remain contained even if home values were to plunge 20+%.

      1. The information would be fascinating if CMHC and OSFI were to open up their compliance and audit records for public consumption.

        Then we wouldn’t have to guess and make assumptions.

        1. Fascinating indeed. I suspect they’ll never name individual lenders who don’t make the grade — at least not lenders still in operation. But such data could (and should) be made available in aggregate form. I’ve heard the regulatory arguments against doing so and they don’t hold water. Investors and Joe Public need to understand how well OSFI, CMHC and other watchdogs do their jobs, and arrears data aren’t a sufficient gauge of that.

  2. A good point, Rob. A better term would be non-bank lenders, perhaps. All are regulated but to varying degrees.

    Also, I don’t share the “shorts'” thesis on Home Capital Group. Payout ratios and capital ratios are much lower and higher, respectively, than the Canadian banks, but probably should be given their relative size. Still, despite the runup in the stock prices, both Home Capital Group and Equitable Group look extremely attractive, to me at least, on multiple valuation metrcs – if I wasn’t already over-exposed to the financial services sector equity class in Canada.

    That being said, neither of those two mentioned are non-bank lenders, both operating chartered bank and trust entities, though I am pleased to see Home Capital Group actually merged RedBrick Bank into CFF Bank and now integrating the renamed Home Bank into the same technology platform as Home Trust.

    As for the concern over a subset of Home Capital Group’s mortgage brokers, that was a concern that ultimately served as a wake-up call that brought greater diligence, and yes, paperwork. However, didn’t even BMO have a similar problem a few years ago?

    Street Capital will be a bank lender soon too, finally after many years of delay. The concern I have is with the lower regulatory burden non-bank lenders utilize. What is their market share of outstanding mortgage balances and of new originations, both securitized and on balance sheet? Does the quoted 15% include the above? If so, the Globe shouldn’t. Who are the major non-bank lenders remaining besides First National and the so-called “mortgage REITs” like Fisgard and Capital Direct and what is their share?

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