OSFI Flags Underwriting Issues Related to Income Verification
In its first Annual Risk Outlook, OSFI identified several potential issues in the housing market and outlined planned and potential regulatory responses.
The report from the Office of the Superintendent of Financial Institutions (OSFI) covers risks related to everything from cyber-attacks and climate change to housing and corporate debt funding.
On housing, OSFI singled out risks associated with income verification for specific mortgage types, including self-employed and rentals.
“Recent supervisory reviews identified several common issues around underwriting, specifically income verification in areas that have been raised as being problematic in the past including business for self, rentals, exceptions to income sustainability as well as collateral management,” the report reads.
“Recent growth in such lending has amplified risk for lenders,” OSFI added. “Supervisory review work has revealed that lenders need additional guidance to ensure their underwriting policies align with the principles of Guideline B-20.”
OSFI added that it will consider applying the B-20 guidelines to other mortgage products, including reverse mortgages, mortgages with shared equity and combined loans plans (CLPs), given the “prevalence” of these products.
It also noted that the “unprecedented” run-up in the housing market, “driven by very low interest rates and imbalances in the housing supply/demand,” have increased real-estate secured lending exposure for lenders.
Risk weighting for investor mortgages to increase in 2023
OSFI confirmed it will take direct action against investor mortgages by way of additional rules as part of the international Basel II guidelines.
Investor-class mortgages have come into focus recently, as they now represent close to one-third of recent residential home purchases.
“…as part of the domestic implementation of the Basel III reform package in banks’ fiscal Q2-2023, we are increasing the risk weights, and thus capital required, for investor mortgages compared to the risk weights for owner-occupied properties,” the report reads.
While it’s not clear what this will translate to in terms of specific regulations, an increase in risk-weighing will likely mean a higher down payment requirement compared to owner-occupied mortgages.
Changes coming to the stress test?
While nothing was confirmed regarding potential changes to the Minimum Qualifying Rate (MQR), A.K.A., “stress test rate,” OSFI did say it is “prepared to make changes at any time if conditions warrant.”
Its next scheduled review of the MQR is December 15 of this year.
Given the recent rise in fixed mortgage rates, many new borrowers are facing a stress test rate above the MQR of 5.25%, which currently qualifies borrowers based on the higher of their contract rate plus 2% or the stress test floor rate of 5.25%.
“As mortgage rates edge upward on expectations of tightening monetary policy, and as the severe-but-plausible risk of a housing market downturn remains, homebuyers and lenders alike will have greater confidence to weather negative shocks with the minimum qualifying rate (MQR) ‘stress test,'” OSFI said in its report.