Mortgage Broker

20 | fall 2017 cmba-achc.ca CMB MAGAZINE overprotection exhibit 1 provides a hypothetical example of a bank that owns a single asset: a mortgage loan on a $1 million house. For simplicity, the example excludes transaction costs such as legal fees. It also assumes the lender cannot recoup losses through recourse 2 and the loan has just been originated, so no payments have been made or missed. With an insured residential mortgage, a homeowner's equity can be as low as $75,000. But a minimum of $200,000 is required for the uninsured mortgage. e value of the property would have to decline by 20 per cent or $200,000 before Bank ABC would incur losses in the event of a default. For losses higher than 20 per cent, there would be capital depletion starting with the target level of capital and buffers of capital in excess of minimum capital requirements. If bank capital deteriorates below minimum capital requirements, Bank ABC could be considered at risk of insolvency and subject to regulatory actions including OSFI taking control. In addition to capital requirements, there are other OSFI guidelines that govern how financial institutions manage credit and other risks. A guideline on corporate governance sets out OSFI's expectations for the board in areas including risk appetite and internal controls. Uninsured residential mortgages are also subject to the existing requirements in the current version of the underwriting guideline for residential mortgages. As part of its supervisory process, OSFI will intervene at an early stage should it have concerns over an institution's financial condition or policies and procedures. FSB Standard and the U.S. Subprime Saga e impetus for OSFI's original B20 Guideline on residential mortgage underwriting was a standard introduced by the international Financial Stability Board (FSB). Modern financial regulation is largely shaped by global standards. In the case of bank regulation, most standards are set by the Basel Committee on Banking Supervision whose membership consists of bank supervisors from several jurisdictions including Canada. For example, this committee has established the Basel Accord, upon which OSFI's capital requirements are largely based. However, some international standards are set by the FSB, which addresses issues related to global financial stability on behalf of the G20. In April 2012, the FSB released Principles for Sound Residential Mortgage Underwriting Practices. e principles cover: n the verification of income and other financial information; n the debt service coverage; the loan-to- value ratios; n the collateral management; and the use of mortgage insurance. e FSB standard was a reaction to the role that U.S. subprime residential mortgages played in the global financial crisis. e FSB press release for the standard stated: "Problems arising from poorly underwritten residential mortgages contributed significantly to the global financial crisis. As the global crisis demonstrated, the consequences of weak residential mortgage underwriting practices in one country can be transferred globally through securitisation of mortgages underwritten to weak standards. As such, it is important to have sound underwriting practices at the point at which a mortgage loan is originally made." Subprime mortgages are U.S. loans that do not meet the repayment standards of government-sponsored entities, such as Freddie Mac. One of the most infamous segments of these loans was described as "NINJA," which stood for "no income, no job and no assets." Originators financed subprime loans through securitization structures in which pools of mortgages were used to create packages of securities that were sold to investors, including financial institutions in other countries. Was there any reason for the FSB principles to be implemented in Canada other than compliance with the international standard? e problems that emerged in the U.S. subprime market were practically non-existent in Canada – and continue to be non-existent. is is evident from the arrears data in figure 1. A mortgage is in arrears if the borrower is more than 90 days behind on their mortgage payments. e figure shows that the arrears rate during the global financial crisis never exceeded 0.45 per cent in Canada. Arrears in the U.S. have been consistently higher and spiked during the financial crisis. e arrears data suggest that underwriting standards in Canada are high and did not deteriorate over the course of the global financial crisis. Canada has a very different market than the U.S. for mortgage-backed securities. e Canadian market is dominated by Canada Mortgage and Housing Corporation (CMHC) securitizations in which repayment of interest and principal is government guaranteed. New issuance of residential mortgage-backed securities has been close to nonexistent in Canada in recent years. Hence, the possibility of mortgage risk being transferred to other countries is a non-issue. exhibit 1: Bank aBC homeowner's equity (20%): $200,000 Mortgage loan (80%): $800,000 figure 1: residential Mortgage arrears in source: Canada Mortgage and housing Corporation (n.d.). 2 outside of Alberta and Saskatchewan, uninsured mortgages are pre-dominantly "recourse" meaning the borrower cannot simply walk away from a house if its value declines to the extent that the borrower's equity is eliminated. The lender can seek the borrower's other assets to help pay for the losses.

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