Peter Routledge: Why OSFI is increasing the margin of safety for real estate secured lending

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Housing markets are prone to bouts of ebullience, but solid underwriting bucks that trend

There is a for sale sign in front of a house in Toronto. There is a for sale sign in front of a house in Toronto. Photo by REUTERS/Carlos Osorio/File Photo

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The affordability of housing and in particular the dream of owning a home for first-time buyers are topics that receive a lot of attention in the national discourse. Canadians are concerned about housing affordability amid the exuberant rise in home prices since the start of the COVID-19 pandemic. More recently, the impact of high inflation and rising interest rates on the housing market has compounded these concerns.

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I head the Office of the Superintendent of Financial Institutions (OSFI), an organization whose supervisory and regulatory powers can and do have a significant impact on the Canadian housing market. More importantly, OSFI’s influence on the housing market may have left some observers with the impression that OSFI is Canada’s housing market regulator. We are not.

OSFI’s mandate requires us to oversee and regulate the vast majority of lenders in Canada’s home finance system in a way that improves their resilience and, in turn, the resilience of home finance. Our primary responsibility within Canada’s housing system is to ensure that Canadian federally regulated lenders manage their risk in a manner that promotes sound credit quality under Secured Loans (RESL).

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This means that the variance in the quality of RESL does not increase to a level that results in a systemic worst-case shortage of housing credit availability. If we have reasonable expectations of the institutions we oversee, just enough to ensure sound risk management in home finance, but not so far as to unduly restrict access to home finance, then we have accomplished our mission of building public confidence to contribute to the Canadian financial system.

Since the 2008-2009 global financial crisis, OSFI has consistently taken action to promote solid RESL credit quality. We have gradually changed the amount of principal that must be held by regulated home loan lenders (i.e., home mortgages and home equity lines of credit, or HELOCs).

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Since its initial publication in 2012, we have revised several times a document we call Guideline B-20: Residential Mortgage Practices and Procedures, which sets out a set of expectations for residential mortgage origination. These closely monitored expectations support prudent home mortgage underwriting across the home finance system, resulting in solid credit quality and therefore long-term credit availability.

We also introduced a Minimum Qualification Rate (MQR) for uninsured mortgages in 2017 (the Treasury Secretary is doing the same for insured mortgages). This means that lenders must qualify potential borrowers at a mortgage rate higher than their contractual rate, be it variable or fixed. This adds a crucial margin of safety that improves the borrower’s ability to absorb unexpected changes in interest rates or income. Nonetheless, we would consider changes to the MQR if we believe such changes would improve the resilience of Canadian housing finance.

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Although the MQR attracts a lot of public attention, it is not the only tool we use to fulfill our mandate in the home finance sector. For example, on June 28th we issued a recommendation setting refined expectations for the treatment of some mortgage-backed lending products.

In short, we expect lenders to build more margins of safety in the design and underwriting of Combined Loan Plans (CLPs) and other innovative lending products that could pose unique risks to home finance resilience.

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Our expectations include that lenders ensure that all combined borrowings above a 65 percent loan to value (LTV) are amortizing and non-repayable. This discourages lenders from allowing interest payments on mortgages with LTVs over 65 percent. In doing so, we reduce the vulnerability that arises when borrowers maintain high LTV ratios beyond contractual payback periods.

We also publicly reiterate our expectations for lenders to improve collateral management, property valuation and longevity risk management for reverse mortgages. And on top of that, lenders make sure their mortgages on homes with shared-equity properties have priority on the property.

History teaches that housing markets are prone to exuberance. At OSFI, we buck this trend by encouraging sound underwriting with the lenders we regulate. In doing so, we want to contribute to public confidence in the Canadian financial system.

Peter Routledge is the Superintendent of Financial Institutions

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