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The OSFI aims to further tighten standards for the subscription of mortgages, questions on the revision of Directive B-20 for comments
The Office of the Superintendent of Financial Institutions (OSFI) published a revision of the B-20 Draft Guideline (Residential Equity underwriting Practices and Procedures) on 6 July 2017. The draft guidance comes after the OSFI published a July 7, 2016 issue to the sector in which it highlighted its concern about private mortgages subscription practice and the appropriateness of the checks on credit quality carried out by private mortgages initiators.
It was noted in the memorandum that OSFI will revise Guideline B-20 to make sure it is consistent with circumspect sector practices and the reality of the Canadian rental markets. This draft policy is the result of OSFI's verification. There has been no change in the underlying scope of Guideline B-20: the five key fundamentals for solid subscription to real estate continue to apply.
OSFI has, however, raised and specified its aspirations and added new one. The changes reflect OSFI's concern about the Canadian mortgages market: possible real estate bubbles in Vancouver and Toronto, the probability of interest rate hikes and their potentially adverse impact on high-debt homes, and government control.
Some of the new actions suggested by OSFI in the draft Guidelines to meet these needs are considered below. The OSFI requires lenders and insurance companies to show an appreciation of and adequately address exposure to mortgages portfolios. Accordingly, the state-regulated finance institutes (FRFIs) granting private mortgages are now required to check whether their business with private mortgages is well backed by careful subscription policies and has robust riskmanagement and in-house control appropriate to these transactions.
It is also recommended that Frontiers should regularly review their Residential Mortgages Underwriting Policy (RMUP) to make sure there is a high degree of consistency between their willingness to take risks and their effective guidelines and practice in the areas of reinsurance, acquisitions and RM. The Canadian government last autumn heralded stricter regulations for mortgages in Canada to force all home owners to claim mortgages at an interest level higher than their contract mortgages and the Bank of Canada's traditional five-year five-year postal interest of 4.64 percent.
Using the higher interest calculation for calculating the borrower's Gross Debenture Guarantee, which may not be higher than 39%, and the Total Debenture Guarantee, which may not be higher than 44%, France's Financial Institutions (FRFIs) are now assessing the borrower's capacity to repay his mortgages even if interest levels increase.
Those current demands on secured housing loans are already mirrored in the credit servicing capacity demands of mortgages insurance companies, and the draft Directive provides that OFIs should fulfil those demands. The draft Directive now makes the stricter test regime applicable to unsecured mortgages, but in some ways even goes beyond the stricter test regime for secured mortgages.
In the case of non-insured mortgages, the OSFI anticipates that the FRFI will take into consideration present and prospective terms when assessing qualified interest and make appropriate decisions and at least make sure that non-insured borrower can sustain an interest increase of at least two percent above the policy interest level. Nevertheless, the OSFI expectations mean that creditors should assess the risk inherent in each credit request and take appropriate action to test credit risk; reliance on the 2% threshold will not be enough in all cases.
The OFSI has raised concern about the overvaluing of certain of Canada's property market areas, such as Greater Vancouver and Toronto, and some suggestions in the draft guidelines are designed to make sure that any risk associated with a possible decline in these or other property market areas is adequately controlled and alleviated. Accordingly, the draft Directive provides for stricter rules for the determination of the loan-to-value (LTV) for a home construction credit.
The OSFI requires the FRFI to critically review the viability of real estate markets and make appropriate adjustments to real estate value when making an actuarial determination on non-compliant loans and Home equity line of credit (HELOC), which includes the calculation of the LTV and the price of the credit. The OSFI also anticipates that Frontiers will lower the LTV limit ceilings for several riskier assets or defects in a credit request.
This means for a HELOC that the HELOC's carrying amount must be reduced if there is a significant impairment of the asset. Such a development may adversely impact the ability of a HELOC to compete on the market, especially if real estate prices begin to fall. OSFI's expectation of the kernel's kernel of kernel and kernel processes has been raised from "sufficient" or "reasonable" to "strict" in a few cases.
Thus, for example, the current guideline B-20 calls for "reasonable steps" to obtain evidence of incomes, while the draft guideline calls for a " vigorous effort " by FPIs to review incomes. In the case of mortgages covered by policy, the French Financial Institutions (FRFIs) must now request evidence of non-life cover and, in the case of mortgages covered by policy, obtain evidence from the mortgages-insurer confirming their obligation to cover the mortgages.
Proof from the insurance company is necessary for all covered mortgages, whereas previously proof of the insurance company's consent was only necessary if there could be an exemption from the insurance company's subscription guidelines. This draft Directive extends the obligation to describe the objective of the credit. Added a new section under Principle 2 entitled "Purpose of the mortgages loan".
In this new section, the OSFI requires the FRFI to identify and record the purposes of the future loans, as well as the proposed use of the loans, the method of acquisition or refund. The OSFI believes that the objective of the loans plays a pivotal role in the assessment of borrower exposure. Real estate, for example, which is dependent on rent revenue to serve the loans, requires the creditor to know the rent markets and to include all associated exposures in its lending decisions and subscription workflows.
OSFI, as a supervisory authority, focuses on making sure that creditors apply the same strict rules of endorsement and lending decisions for overseas and local purchasers. For this purpose, the draft Guideline emphasises that if borrower are dependent on revenues from outside Canada, creditors must carry out a careful review.
This may lead to fewer overseas purchasers qualifying for a private mortgages, leading to a slowdown in the market. FrIs are required to notify presumed or verified frauds or false information to the home mortgages provider if the request for mortgages is for an assured one. No FRFI can borrow more than 80 per cent for the value of a mortgages without taking out mortgages cover.
The OSFI also anticipates that the FRFI will prescribe a maximal LTV rate of less than or equalling 65 percent for flawed private loans, which may involve low-income qualified loans, loans to persons with low creditworthiness and loans on illiquid real estate. The draft Guidelines state that no FRFI should in any way arrest or agree with any other creditor a mortgagor or mixture of a mortgagor and other loan product backed by the same ownership that would circumvent the LTV limit or other restrictions that it sets in its MRP.
Accordingly, it will be prohibited for any FRFI to enter into agreements with non-regulated mortgagors, in particular MICs, in order to provide mortgages that go beyond the mandatory thresholds. The OSFI has made it clear that a "home mortgage" covers any credit to a debtor backed by home ownership, as distinct from a credit to a person backed by home ownership, as currently provided for in Guideline B-20.
The amendment removes any uncertainties as to whether Directive B-20 applies to a home loans to a limited company or other undertaking. Any FRFI acquiring housing loans from third parties must take into account the risk associated with the function that the third parties may perform in relation to the loans obtained, in particular serving function.
An FRFI will want to make sure that it has properly valued the exposure to credit risks from counterparties when purchasing housing loans, whether for its own account, as a borrower aggregate or for incorporation into a management system funded by the institution. Any FRFI dealing with retail mortgages or the purchase of retail mortgages will need to pre-empt any changes in its Governance and underwriting processes and will need to address now which operative changes need to be put in place after the draft Guidelines are finalised.
Special consideration should be given to the stricter norms that OSFI are expecting. According to the current Guideline B-20, FRFIs acquiring housing loans granted by a third person should make sure that the subscription standard of that third person is in line with the FRFI MMRP and with the current Guideline B-20.
The draft Directive maintains this obligation, so that even non-FRFI mortgagors who are selling their loans to FFIs will have to upgrade their procedures to make sure that they are able to do so. Until 17 August 2017, the sector has time to comment on the draft directive.
The OSFI will post an unattributed abstract of the statements they received together with the OSFI replies on its website when the definitive B-20 guidance is published. The OSFI anticipates that the definitive directive will be published in autumn 2017 and will enter into force soon thereafter. The OSFI also anticipates follow-up changes to Directive B-21 - Residential Mortgage Insurance Underwriting Practices and Procedures soon after the entry into force of the definitive B-20 Directive.