Bank regulator targets mortgage disclosure

Canada’s bank regulator has issued a set of draft guidelines on mortgage underwriting that, if approved, would significantly increase the level of transparency around one the industry’s most important and least understood businesses.
Based on similar principles released by the Switzerland-based Financial Stability Board at the end of last year, the proposed rules require bank boards of directors to approve their institution’s mortgage underwriting polices at least annually, and that those policies be based on “timely, accurate, independent and objective reporting” on the risks related to the mortgage business.
Lenders would also be required to provide a lot more information on their mortgage portfolios than they do now, including the use of default insurance, geographic concentration of loans and lending to employees.
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National Bank Financial analyst Peter Routledge said he was “surprised” at the lengths the guidelines go toward shining a light on what many observers say is a poorly understood part of banks’ business.
“This will broadly increase the level of disclosure and it will certainly help investors figure out who has more credit risk,” Mr. Routledge said.
The Office of the Superintendent of Financial Institutions has invited public comment on the draft rules until May 1. Brock Kruger, a spokesman for OSFI, said the completed guidelines will likely be issued before year-end. The announcement comes amid growing worry around the country’s housing market and escalating household debt.
Mark Carney, the governor of the Bank of Canada, has identified record consumer borrowing as the biggest domestic threat to the stability of the financial system, warning that the situation has left Canada exposed to economic shocks such as a spike in unemployment or interest rates.
“Although financial institution mortgage portfolios continue to perform well, a number of vulnerabilities in the financial system exist, including high household indebtedness,” Mark Zelner, assistant superintendent, said in a statement. “OSFI is acting in an effort to prevent these vulnerabilities from evolving into problems for the financial system.”
Although the proposals put out by OSFI are based on guidelines issued by the Financial Stability Board, the top international regulator, there are several key differences including the requirement for board-approved underwriting principles, potentially the most important.
Players would also have to exercise the same due diligence and abide by the same lending standards on loans collateralized by homes — called home equity lines of credit, or helocs — as they do on mortgages.
In addition, they would be required to provide sufficient disclosure on residential home loans for investors “to be able to conduct an adequate evaluation of the soundness and condition of a federally regulated financial institution’s residential mortgage operations.
“This is a welcome development because it gives us a lot of visibility that we didn’t have before,” said Dave Beattie, an analyst at Moody’s Investors Service.
The guidelines cover all federally regulated financial institutions involved in mortgage underwriting or insurance. However they do not cover the Canada Mortgage and Housing Corp., the largest issuer of mortgage insurance, which is overseen by the federal Department of Human Resources and Skills Development.
Canadian mortgages outstanding currently total about $1-trillion, about 60% of which is covered by CMHC default insurance.
Analysts say a central concern is lack disclosure around helocs, one of the most popular retail products ever offered by the banks. While some lenders include the value of helocs in their mortgage portfolios, others break them out separately. Still others lump them with consumer loans. The new guidelines would go a long way toward clearing up the picture.
Another problem that the rules would fix is what some observers regard as excessive flexibility around heloc repayment. As revolving lines of credit, these loans don’t necessarily come with strict amortization requirements. Indeed, some lenders only stipulate that at a minimum borrowers make interest payments. With interest rates close to record lows, this makes it easier for borrowers conceal financial problems.
Under the new rules, lenders would have to impose the same level of due diligence on heloc underwriting as on sub-prime mortgages. They would also have to ensure that the borrower has the ability to expect “full repayment over time.”