Office of the Superintendent of Financial Institutions (OSFI) is signaling that it will be taking more action to address mortgage approvals that rely on the equity in the property at the expense of assessing the borrower’s ability to pay the loan. It has not stated what the changes will be or when they will be made.
OSFI’s Review of the B-20 Changes
In its recent fall newsletter (see attached), OSFI reviews the changes it made one year ago to its Residential Mortgage Underwriting Practices and Procedures (B-20), including the results and ongoing risks.
Overall, OSFI concludes that, “the B-20 revisions are having the desired effect of helping to keep Canada’s financial system strong and resilient.”
OSFI’s Observed Successes
OSFI notes the following observations:
- Stress tests have been incorporated into lenders processes.
- Improvements are evident in the quality of new mortgage loans, including higher average credit scores and lower average loan-to-value at mortgage origination.
- Markets with rapid house price appreciation experienced a higher impact. That is, B-20 measures along with higher interest rates and other actions, have had a higher impact in markets like Vancouver where average loan-to-value ratios for new mortgages have decreased.
- Reduced number of highly indebted or over-leveraged individuals. The proportion of uninsured mortgage originations that have loan amounts greater than 4.5 x’s borrower income declined from 20% in April-July 2017 to 14% in the same period in 2018.
- Critical reviews of property appraisals are being done. OSFI notes that “work is being done by financial institutions on policies to ensure critical reviews of property appraisals are being performed as part of the due diligence process”.
Noted Concerns and OSFI’s Views on Them
OSFI does note the following:
- Lending on equity versus ability to repay is a concern. OSFI says that “although reduced, there continues to be evidence of mortgage approvals that over rely on the equity in the property (at the expense of assessing the borrower’s ability to repay the loan); OSFI will be taking steps to ensure this sort of equity lending ceases”
- Consumers looking outside the regulated system not a big concern. During the consultation period prior to the B-20 revisions, OSFI was made aware of several concerns, including that the changes could lead borrowers to look outside the federally regulated system for loans. It seems not concerned about this risk, as OSFI notes that the federally regulated share of residential mortgages among regulated lenders in Canada for the 12-month period ending June 2018 remains stable (76.9% down to 76.7%), and many lenders regulated by provincial regulators have adopted similar underwriting practices.
- Consumers being tied to lenders (renewals) also not a big concern. OSFI says that another concern was that B-20 would force a number of borrowers to remain with their current lender on renewal, potentially leading to an increase in their mortgage interest rates. Although it appears more borrowers are staying with their original lender (renewals are up 30% while new mortgages are down 19% year-over-year in the April to July period), there has been no material change in the difference between the rates that renewal customers pay and those offered to new customers.
Expected Changes: Overreliance on Home Equity versus Ability to Repay
With regards to the OSFI’s statement that it will be taking steps to ensure this sort of equity lending ceases, OSFI spokeswoman Annik Faucher told the Financial Post in an email that the regulator was referring to:
- Uninsured mortgages that were granted based only on the equity of the property — i.e. the difference between a property’s value and the amount remaining on a borrower’s mortgage for the property, as well as
- Loans where the lender did not necessarily apply the other “prudent underwriting principles” laid out in the B-20 guideline, such as those aimed at proper documentation of income.
Ms. Faucher said that OSFI “has a number of tools in its supervisory toolkit, and when we identify potential issues, we intervene and require financial institutions to implement remedial measures that are commensurate to the risk profile of the institution.”