6 minutes
New regulation is akin to the U.S. rule of ‘ability to pay.’
Effective Jan. 1, federally regulated financial institutions in Canada are now required to meet the new Mortgage Stress Test Rule handed down from the Office of the Superintendent of Financial Institutions. While the rule won’t directly impact provincially regulated credit unions, there could be a trickle-down effect—resulting in both potential opportunity and risks for Canadian CUs.
The rule requires buyers with uninsured mortgages to prove they can afford payments based on the greater of the Bank of Canada’s five-year benchmark rate (currently 4.99 percent) or their contract mortgage rate plus two percentage points. (Read more about qualified mortgages and the ability to repay in the U.S.)
Stephen Kerr, a partner at the Canadian law firm Fasken Martineau, Toronto, shares his perspective. Specifically, he describes how Canadian credit unions can evaluate their mortgage underwriting guidelines to prepare for and perhaps take advantage of the new rule.
First, how will borrowers withstand this stress test?
SK: Borrowers must be able to afford payments based on the new stress test rule, which theoretically is a two-percentage-point increase of their current rates.
What about the fear of borrowers seeking unregulated lending?
SK: The intent behind the OFSI decision is to cool the currently robust Canadian real estate market. It wants to ensure that banks are adequately capitalized and not taking on too much risk, which could cause a perceived risk to their depositors and consumers at large.
Will it be harder for the consumer to get a mortgage?
SK: From federally regulated lenders, yes, it may be conceivably more difficult. For example, borrowers may find it challenging to provide a 20 percent down payment and meet or sustain the 2 percent stress test rule. But OFSI isn’t primarily concerned with these real estate variables. Its priority is protecting depositors, and cooling the housing market is a way it is trying to manage risk in this area.
How will the ruling impact provincially regulated CUs?
SK: There is no direct impact, but I believe it will lead to increased mortgage underwriting opportunities for provincially regulated credit unions, at least initially. Consumers impacted by the rule and wanting to buy a home will search out other options, such as finance companies, which have no regulations but higher rates and fees. However, they may also look to their local credit union.
Will this prompt credit unions to adopt similar standards or even the same stress test rule?
SK: I suspect that credit unions may tighten some of their underwriting guidelines, but I believe most see the OFSI policy as an overreaction; Canadian banks are well capitalized and can withstand a real estate downturn. I don’t foresee regulators at the provincial level adopting standards as aggressive as these, but this obviously remains to be seen as it is more typical than not that provincial regulators echo some of the policy imperative to their federal cousins. Credit unions are much smaller than banks, and their focus is on a smaller, more local depositor base.
Compliance at the provincial level is also less rigorous than what a larger national bank would employ. Credit unions know their client base, and rather than depending on large amounts of resources to bolster compliance, they focus on interpersonal connections. In fact, they may already be financing homes for members who don’t qualify for the stricter OFSI standards or a typical bank mortgage.
What do you predict for credit unions wanting to capture more of the mortgage market during this window of opportunity?
SK: There will be credit unions that will want to take on this segment and will view it as an opportunity. Mortgages are already a significant piece of their business. Additionally, consumers will look to either credit unions or non-regulated finance companies to get the loans they may not qualify for otherwise. I could see consumers staying with a CU mortgage product for, say, an initial five years and then look to the federally regulated banks to refinance when they qualify, either for better pricing (rate reduction) or access to a broader suite of products.
What other advice do you have?
SK: From a business perspective, there is an opportunity to market to this segment, one that has historically sought bank financing.
These could be first-time home buyers and/or younger people and/or middle- to lower-income [people], but not necessarily. These may be people who have existing homes (with healthy mortgages) financed through banks but when the mortgage comes up for renewal may not be able to thread the needle and will have to go elsewhere. In short, it is difficult to generalize the demographic makeup. One common element is that these are “traditional” (i.e., bank) borrowers who have never had to look elsewhere until now—that is the opportunity.
If a credit union decides to tap into this segment, exercise thoughtful planning and take steps to understand this demographic. Will they be representative of a credit union’s current member base? Or will they be more (or less) risky compared to its current portfolio? When credit unions understand who it is they are marketing to, they can adjust underwriting guidelines accordingly—to address a potentially different level of risk.
Also understand that this may be a temporary boom.
Much will depend on what the regulators for provincial credit unions decide. Will they follow suit and draft similarly tightened guidelines, or will they make only minor compliance adjustments? If the mortgage market doesn’t cool as anticipated, what’s next? This may result in a short-term effect on the industry, but not much in the long-term.
So, avoid over-anticipating the potential for business.
Additionally, by taking on this new segment, how much will it impact a credit union’s application intake or volume? With increased intake, a CU will want plenty of staff to do the proper underwriting and who understand any new levels of risk it may be acquiring.
Create a risk profile now—compare the new segment’s level of risk to the existing borrower base; this will help to determine what changes may be needed to underwrite the loans. Also consider implementing internal stress test rules, but keep the option to approve the mortgage, even if the member can’t meet the parameters. The result may still be instructive and will help the credit union manage the risk associated with this market segment.
There will be both challenges and opportunities with the new stress test rule. The key is to be prepared and ready when members seek new mortgage alternatives.
Stephanie Schwenn Sebring established and managed the marketing departments for three CUs and served in mentorship roles before launching her business. As owner of Fab Prose & Professional Writing, she assists CUs, industry suppliers, and any company wanting great content and a clear brand voice. Follow her on Twitter @fabprose.
