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Is This the Last Nail in the Coffin?

Sledgehammer FBThe Feds clearly wanted to crack the housing market, and they may have finally done it, with a sledgehammer.

New Department of Finance (DoF) rules will hit the mortgage market hard, but consumers will take the brunt of the blow. The two big changes:

1) Effective Oct. 17, the qualification rate will now apply to all high-ratio insured mortgages, even 5-year fixed terms. On Nov. 30 it applies to insured low-LTV mortgages as well.

2) Regulators are banning a wide array of mortgages from being insured, effective Nov. 30.

One big non-bank lender didn’t mince words when describing today’s DoF’s announcement. “This is a crisis,” the executive told CMT. The lender estimates that up to 40% of its insured volume could vaporize near-term because of these rules. Even if it’s half that among non-banks industry-wide, this appears to be a devastating blow to mortgage competition in Canada.

Background: Non-bank lenders rely on default insurance because it (in the DoF’s words) “supports lender access to mortgage funding through government-sponsored securitization programs.” Banks don’t depend on insurance to the same extent (at least not on conventional mortgages) because they don’t have to sell their loans to investors.

You’d think that with such a drastic policy change that stakeholders would be thoroughly consulted. Nope. Lenders I spoke with had not even a hint this was coming.

So what happens now? Here are our top 10 predictions:

    1. Housing prices will tumble as a sizable minority of first-time buyers and those with higher GDS/TDS ratios no longer qualify for the mortgage amount they want.
      • Forcing all insured borrowers to prove they can afford a payment at the posted rate (4.64%) will remove up to 15-20% of buyers from the market, say lenders.  
      • “This will impact more than 50% of borrowers’ [mortgage] limits, among those who select 5-year fixed rates,” said Mortgage Planner Calum Ross. “As unpopular as this may be to say, however, I fundamentally believe this is the right move by regulators. The fact they allowed such a large disparity on the qualifying rate for such a long time was, in my opinion, not a prudent lending decision.”
      • Others argue that 5-year fixed borrowers with 10%+ down payments could have refinanced and re-amortized after five years anyhow (to reduce their payments and mitigate a 200+ bps rate increase). Mind you, a 200+ bps hike in the next five years would probably cause a recession, so it’s unlikely at best.)
    2. Non-deposit-taking lenders could be forced to sell a wide array of loans to balance sheet lenders at a premium. They’ll be forced to pass those funding cost hikes directly through to consumers. These include refinances, amortizations over 25 years, non-owner-occupied properties and mortgages over $1 million—all the stuff that can no longer be insured and securitized.
    3. Broker market share will fall.
      • It’s Christmas in October for the banks. Among other things, they’ll gain refinance, jumbo mortgage and rental business from the monolines.
      • That business boost will reduce their reliance on the broker market. In fact, don’t be surprised if a Big 6 bank exits the broker channel by this time next year.
    4. Mortgage availability will drop in high-valued regions like Vancouver and Toronto and rates will rise nationally.
      • This liquidity drop is partly because of the insurance prohibitions, and partly because of higher capital requirements for insurers. This latter measure was announced previously and is expected to take effect in Q1. Word on the street is that bulk insurance premiums (which average roughly 40+ bps now) could at least double.
      • As competitors raise rates, banks will likely take that opportunity to hike their own rates. And they’ll probably do it nationally because regional pricing presents internal challenges.
    5. Banks will also have to qualify conventional borrowers at the posted rate on all terms.
      • OSFI tells us, “…Our update to [Guideline] B-20 is going to reflect the announcement made by the Department of Finance today about [the] “Mortgage rate stress test…” But it adds, “We are still reviewing the guideline, and have not yet made decisions in this regard.”
      • That suggests monolines could potentially be at a disadvantage for a while, unless OSFI encourages banks to adopt a standard 5-year posted qualifying rate sooner.
    6. Market share for near-prime lenders will rise yet again, especially for refinances.
      • Consumers, of course, will pay significantly higher interest for these lenders’ flexibilities.
    7. There will be a mad dash to refinance under the old rules prior to October 17th, when the new qualification rate comes into force.
      • Expect most lenders to stop taking such deals by mid-next week.
    8. We’ll start hearing more economists forecast a Bank of Canada rate cut due to the GDP hit from these rules.
      • Two big pillars of Canada’s growth, oil and housing are now on the ropes.
      • As we’ve written before, this is probably the worst time to send a message to foreign investors that they’re not welcome in Canada’s housing market. Canada needs their investment and most politicians and policy-makers appear shockingly blind to this.)
    9. Non-balance sheet lenders could apply rate premiums to amortizations over 25 years since they can no longer be insured. That’s no small point. Mortgages with amortizations longer than 25 years accounted for over half of all portfolio insurance underwritten by CMHC through June.
    10. Morneau
      Finance Minister Bill Morneau

      MBS yields will fall as supply drops and pool risk improves (more on that from Bloomberg). Yay, some good news in all this.

In the long run, the DoF’s move adds housing stability (at what cost is the question). But most of the 70% of existing homeowners who value their equity may well curse regulators in the short run.

The sad part is that borrowers in the majority of the country are clearly paying a price for Vancouver and Toronto’s excesses. “What I find most frustrating is that this change penalizes the wrong segments of the market,” said Tyler Hildebrand, a mortgage planner at One St. Mortgage. “Housing policy continues to be set on a national basis without any consideration for regional implications. Real estate is a local business; it should be regulated on a regional basis.”

Of course, the government also announced it’ll prevent non-residents from claiming the capital gains exemption—which is primarily targeted at Vancouver and Toronto. (This is a reasonable move. Here are more details on it). But this measure was a distraction from the other rule changes, and trivial by comparison. Non-resident buyers who buy to flip tax-free are simply not a major price driver nationwide. 

All of this adds to the layers of mortgage regulations imposed since 2008. And, to make matters worse for the lending industry, the Department of Finance has reaffirmed its decision to evaluate lender risk sharing. Charging lenders deductibles on default insurance claims could be an utter disaster for less capitalized non-bank lenders (and hence mortgage competition and consumers), depending on how it’s implemented.

With mortgage tightening finally starting to impact high-valued markets, this new round of rules has come too late, with too little forethought and too many consumer repercussions. It’s effects are so wide-reaching, so sudden, that something has me thinking it’s a conspiracy against non-bank lenders.

But no. I trust Canada’s regulatory system much more than that…I think.