OSFI Focuses Its Microscope on Underwriting



Analysis FB

It looks like it’s going to get harder (and/or more expensive) to get approved for a mortgage—if you’re not a strong borrower, that is.

The nation’s banking regulator (OSFI) put banks on notice today that it’s stepping up policing of their underwriting practices. Here’s OSFI’s official letter.

“Risks associated with mortgage lending practices are, in general, adequately managed by Canadian financial institutions,” OSFI’s Annik Faucher told CMT. “…However we have identified areas that require close attention by mortgage lenders, and at the same time, increased scrutiny by OSFI. As noted in the letter released today, OSFI will continue its scrutiny in the areas of income verification, non-conforming loans, debt service ratios, appraisals and loan-to-value (LTV) ratio calculations, and institutional risk appetite.”

When asked how often OSFI came across imprudent or unduly risky underwriting, Faucher said, “We would not be able to give you a specific number, but as we note in the letter, OSFI is indeed aware of a number of incidents where financial institutions have encountered misrepresentation of income and/or employment.”

Here’s more of what we’ve gathered thus far…

On why OSFI made this announcement:

  • Banks have already been under increased scrutiny since OSFI’s B-20 underwriting guideline took effect in 2012. Among other things, OSFI’s actions have resulted in stricter approval guidelines, more compliance audits, restrictions on securitized lending and more onerous capital requirements.
  • OSFI knows that the public and financial markets are growing more nervous about housing overvaluation by the day. It also probably realizes that both it and the Liberal government will be held partially accountable if any housing markets implode.
  • For these reasons, and due to its legitimate concern about overleveraging and overvaluation, OSFI wants to make a public statement that it’s doing its job of enforcing prudent risk management and protecting bank customers.

On the overall industry impact:

  • One might expect a slight drop in mortgage volumes at federally regulated lenders, other things equal, once lenders adjust to OSFI’s underwriting guidance.
  • Despite domestic lending accounting for about half of Big 6 bank profits overall, this development likely presents only a small earnings challenge.

On expected lender outcomes:110714_0511_OSFIsB21is1.jpg

  • Federally regulated lenders and lenders who source their funding from federally regulated lenders, will be impacted by this announcement.
  • Those lenders will respond in one or both of the following ways:
    • By tightening underwriting guidelines.
    • By making fewer exceptions to their underwriting policies.
  • Most provincially regulated lenders (i.e., credit unions) will not be directly impacted by this announcement when it comes to uninsured mortgages.
  • This could give certain credit unions a slight edge in low-ratio underwriting flexibility, for some period of time.
  • According to analysts we’ve spoken with, capital requirements will increase considerably on a percentage basis come November. However, the impact on an absolute basis should be small, but still large enough to trigger a slight reduction in mortgage discounting.

On how borrowers may fare:

  • Mortgage applicants, particularly foreign borrowers and self-employed applicants who don’t earn a traditional T4’d salary, should expect to be asked for more income documentation (e.g., tax documents, pay statements, bank account statements, etc.)
  • Some homeowners who can’t prove income in the traditional manner will be pushed into the arms of non-federally regulated lenders (credit unions, mortgage investment corporations and private lenders).
  • In turn, more of those borrowers will be forced to pay interest rate premiums, as federally regulated lenders have traditionally provided the lowest cost of borrowing in this market.
  • Lenders will make fewer debt-ratio exceptions. As a result, a small percentage of borrowers will see their requested loan sizes cut back.
  • In certain cases, homeowners with rental income will not be able to use as much of that income to qualify for their mortgage.
  • Lenders may no longer be able to rely on the 5-year posted qualifying rate (currently 4.74%) when measuring a borrower’s debt ratios. If this qualifying rate is raised, it will further restrict credit (maximum loan amounts) for borrowers with above-average debt loads.
  • Some lenders may start calculating and relying on more conservative lending values, as opposed to normal appraised values. This could slightly reduce the equity available to homeowners, a key consideration for those who want to refinance up to 80% of their property’s value (the current refi limit for prime mortgages).

Questions

One of the key questions remaining:

The qualification rate is currently established as the mode average of the Big 6 banks’ 5-year posted rates, as determined by the Bank of Canada. That number is presently 4.74%, about 250 basis points above the typical 5-year rate.

But OSFI isn’t satisfied with that. It says: “Relying on the prevailing posted five-year mortgage rate to test a borrower’s ability to service its obligations in a rising interest rate environment does not represent a sufficiently conservative stress test.”

If OSFI requires a higher qualification rate, that’ll make it harder for many borrowers to get a variable or 1- to 4-year fixed term. We’ve reached out to the regulator for clarity on this point and will update this story once we know.

Update — 6:09 p.m. ET:

Here’s OSFI’s response to the question on whether the qualification rate will be set higher:

Each application is unique, and the qualifying rate is something that financial institutions should look at and ask if it is appropriate as a minimum level to ensure ongoing mortgage affordability. As for future changes, as noted in the letter today, OSFI will be reviewing its Guideline B20 more broadly to ensure it is aligned with prudent industry practice and Canadian housing market realities.

Update 2 — 11:49 p.m. ET:

Here was OSFI head, Jeremy Rudin’s, response when BNN’s Andrew Bell asked if he’d increase the mortgage qualification rate:

“..We’re more inclined to reinforce [a] principles based approach..rather than pick a qualifying rate..”

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Comments

  1. Comment avatar

    Donald Smith    

    This letter will not address the issues.

    OSFI seems to of plagarized a similar theme from the Australian regulator.

    On Dec 14, 2014, the Aussies posted a similar guidance. Here is the link:
    http://www.apra.gov.au/adi/Publications/Documents/141209-Letter-to-ADIs-reinforcing-sound-residential-mortgage-lending-practices.pdf

     
  2. Comment avatar

    Philippe Beland    

    “Relying on the prevailing posted five-year mortgage rate to test a borrower’s ability to service its obligations in a rising interest rate environment does not represent a sufficiently conservative stress test.”

    Really? The streets aren’t exactly full of economists forecasting a sharp rate hike…
    Should such a shock happen, borrowers can always choose a shorter term on renewal or extend the amortization.

     
  3. Comment avatar

    Jeremy Nagel    

    The issue as I see it is not one of qualifying for the home, we have great policy and regulation around that already, but rather the debt accumulated after possession. Everyone needs a roof over their head, but they don’t need all the unsecured higher interest credit facilities.

     

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