By John Greenwood, Financial Post, April 14, 2014 - The Canada Mortgage and Housing Corp. was created by the federal government nearly 70 years ago with a mandate to help smooth the way toward home ownership for millions Canadians who might not otherwise achieve their dream. As a tool of social policy the CMHC has done a pretty good job, but when it comes to market discipline, maybe not so much. In fact critics say that by pursuing its social policy goals so zealously it has distorted the country’s real estate market, helping to push up prices to record levels.
Now Canada’s financial regulator wants to fix the problem.
After two years of planning, the Office of the Superintendent of Financial Institutions on Monday released a set of draft guidelines for mortgage insurance providers aimed at tightening standards around underwriting and risk management.
The proposed rules essentially tell mortgage insurers to pay attention to the basics of their business, like ensuring that the banks they deal with maintain strong lending practices and that the insurance purchasers have good credit quality. It sounds like business 101, but the very fact that OSFI felt it needed to bring in the rules suggests things in the mortgage insurance market were not as they should be.
In a statement, OSFI said the so-called Guideline B-21 rules will “provide clarity about best practices in respect of residential mortgage insurance underwriting, which contribute to a stable financial system.” The long-awaited rules — the regulator first revealed it was developing new standards back in April 2012 — are open for public comment until May 23.
They’re built around several basic areas, including governance and underwriting practices, standards for assessing mortgage lenders, and criteria for determining insurable loans.
The mortgage insurance industry consists of just three companies: the CMHC, which controls the bulk of the market, Genworth MI Canada and Canada Guaranty.
Their policies are backed by Ottawa, and ultimately by the taxpayer.
Perhaps more than anything else, the guidelines put players on notice that they must do a better job of maintaining business discipline and handling risk, and that they will be subject to much closer scrutiny by OSFI.
The bill establishes a framework where regulators “would be responsive to a market where there was more risk-based pricing,” said Finn Poschmann, vice president of research at the CD Howe Institute.
One section that’s garnering much attention in the mortgage industry is a section on down-payments required to qualify for insurance.
As it stands, borrowers who are unable to put down a minimum 20% of the price of a house must purchase default insurance. In the past, some lenders have given the green light to borrowers with no down-payment as long as they bought insurance. They did that by offering certain types of cash-back mortgages. The new guidelines would eliminate that loophole.
“A federally regulated mortgage insurer should establish minimum down payments, as well as acceptable sources of down payment in its criteria,” according to OSFI’s draft document. “In particular, the [insurer] should specify where traditional sources of down payment (e.g., borrower’s own equity) are required and cases where non-traditional sources for the down payment (e.g., borrowed funds) may be used… Incentive and rebate payments (i.e., “cash back”) should not be considered part of the down payment.”
As well, mortgage insurers will be required to consider “acceptable methods” for determining the credit history and quality of borrowers. They will also have to closely scrutinize lenders’ methods of income and employment verification.
Of the roughly $1.2-trillion of Canadian home loans outstanding, more than half are covered by government-backed insurance underwritten either by the CMHC or one of the two smaller providers.
Critics argue that the easy availability of such insurance has significantly boosted the number of potential buyers, pushing up prices and adding froth to the market.
For the past several years, the federal government has been closely scrutinizing the CMHC, with former Finance Minister Jim Flaherty musing publicly as far back as 2012 about privatizing the Crown corporation.
Observers compared this latest move to an earlier set of guidelines focusing on banks’ mortgage underwriting processes. OSFI’s B-20 Guideline, presented in draft form in April 2012, included set of principles around mortgage lending that put responsibility for underwriting standards on the shoulders of banks and their top executives.
Observers say the move helped cool a housing market that appeared to be bubbling over.