The recently announced B-20 Guideline from the Office of the Superintendent of Financial Institutions (OSFI) places new income qualifications on borrowers when obtaining a conventional mortgage at federally-regulated financial institutions (FRFI), mostly banks. Borrowers will have to prove they can afford a loan at @200bp above the quoted rate. The tougher debt servicing test is nuanced but this is the implication of the ‘stress test’. The guideline takes effect Jan 1, 2018. But will borderline borrowers now seek out provincial lenders who are not subject to this new OSFI guideline? Will provinces implement similar measures for credit unions?
As federally-regulated financial institutions (FRFI) account for over 75% of Canada’s mortgage lending, this action will reduce the credit available to prospective home owners. From a regulatory perspective, OSFI is containing the exposure of FRFI’s to an overheated real estate market. From an economic perspective, OSFI is introducing one more measure to dampen market demand. The change affects all bank mortgages where the loan-to-value ratio (LTV) is under 80%, above that they are insured (mostly through Canada Mortgage and Housing Corporation).
An article at canada.com consults Rob McLister of RateSpy.com and he is quoted, “Given where our housing market and debt levels are at, this is the most ground-shaking mortgage rule change of all time. That’s not hyperbole.”
The article continued, “He said a big question now is whether credit unions, which are provincially regulated, will continue allowing people to qualify at the lower, and therefore easier, contract rate.”
Indeed, will the borrowers who cannot qualify at FRFI’s seek out credit unions? The answer is maybe.
In BC the regime is different and there is already a constraint on credit unions making loans where the the LTV exceeds 75%. Credit unions are obliged to hold more capital against these loans. This constraint already makes credit unions more reluctant to make these loans, or to price them to reflect the added capital allocation. Consequently, credit unions will have their own policies and criteria for evaluating these applications. Given the potential exposure to ‘overheated markets’, directors may adjust policies from time to time.
The long standing BC approach to the risk focuses on the collateral value of the property and says that the lender must have more capital for these loans when the owners stake is less than 25% of the value. The test is simple and easily applied. The capital weight for these mortgages is twice that of lower ratio loans, under 75% LTV. Notably, this BC approach has been more conservative than the federal approach for several years.
The OSFI B-20 approach is to prescribe borrower debt servicing criteria. Administratively, this is more complex. This will, introduce a host of subsidiary questions about what qualifies for inclusion as income and which of the stress test thresholds applies. The approach also has the consequence of being applicable to a host of loans where the lender is well secured, the LTV may be only 30-60%. The approach does not target the loans which represent the significant risk of loss to the lender. UBC professor Tsur Sommerville has noted on CBC radio that this new stress test will likely affect moderate income households wishing to seek an increase to their mortgage, even if it is well secured.
On balance, the BC approach makes more sense and attends to the key risk of loss to the lender. It also allows credit unions to take on some added risk ‘if they have the capital’ to support that risk. The BC regulator surveyed credit unions a couple of years ago to assess the extent to which they were vulnerable to a 25% ‘correction’ in real estate market values; the conclusion was that credit unions were not over exposed.
The OSFI guideline may lead some to seek out mortgage loans from credit unions in 2018. But BC credit unions will be cautious in taking these higher risk loans on because of the capital implications. These ‘migrating’ loans should not result in a big change to the risk profile of credit unions.
The change may reduce demand in the housing market, which may also reduce upward pressures on prices. (A related post.)