The Mortgage Market Post B-20. Are the Wheels Coming Off?

Not exactly.

One month after the mother of all mortgage rule changes, the wheels are still turning in Canada’s real estate and mortgage market. They’re just turning slower.

But make no mistake, OSFI’s mortgage stress test has changed the landscape—for both borrowers and lenders. Here’s how:

Fewer Mortgages

• Our best anecdotal guesstimate after speaking to a sampling of federally regulated financial institutions (a.k.a., FRFIs, a.k.a.,  banks) is that prime mortgage originations last month were about 5% lower than January 2017.
  • Blame part of this on the rush of buying before January 1, which caused a small vacuum in demand in January.
  • Borrowers trying to refinance are being hardest hit because their debt ratios are typically closer to the limits.
  • The real test will be the spring market when:
    • mortgage volumes are highest
    • everyone’s November and December pre-approvals (which were qualified under the old easier stress test) expire
    • most lenders must report actual numbers publicly
• In the federally regulated non-prime market, our straw poll suggests the volume drop year-to-date is in the high single digits (some lenders’ alternative volumes are down over 20% since January 1, but that’s not typical).
  • Non-prime FRFIs are having a tougher go because regulators are forcing them to qualify borrowers on inflated payments, based on artificially high rates like 6%. And many non-prime borrowers already have higher debt ratios to begin with (which means it’s harder for non-prime borrowers to pass these new stress tests).
• Don’t believe for a second that banks are giving up on growth. Some may try to offset B-20 by loosening their internal underwriting guidelines a smidge. Others may compete harder for rental financing and/or equity mortgages.

CUs Take a (Small) Bite Out of Banks

• Credit unions that qualify borrowers at the contract rate instead of the overly restrictive bank policy (contract + 2%-pts.) are reporting turnaround times that are three to four business days longer than normal.
• That’s due to an influx of applications from borrowers with higher debt ratios, borrowers who are otherwise well qualified, but who can no longer get approved at a bank (as they have for decades).
• Some myopic regulators (like those in Quebec) threaten to take financing flexibility away from credit union borrowers by forcing CUs to adopt bank rules. Thankfully, common sense policy-makers in most other provinces understand that 4 out of 5 borrowers can qualify under OSFI’s rules, and those who can’t present microscopic default risk. Yes, these borrowers have more debt relative to income, but credit unions are underwriting more carefully than ever (they know regulators are watching) and most importantly, CUs are charging risk premiums (higher rates) to offset any added exposure.

It’s Harder to Afford “Affordable” Homes

• OSFI’s rules are forcing buyers into cheaper homes. Thanks to the new stress test, many would-be borrowers can no longer afford single detached homes in the biggest cities.
• That’s partly why apartment condo sales shot up 22.7% y/y in Vancouver last month. In just three months since the stress test was officially announced, condo prices have popped 3.6%.

Kill-Your-Competition Pricing on Insured Rates

• Consider the average insured 5-year fixed rate of 3.19%. The spread (difference) between that and 5-year swap rates (a proxy for lenders’ funding cost) are 55 bps tighter than one year ago.
• That’s partly because government insurance restrictions mean there are fewer insured mortgages to meet investor demand.
• But OSFI’s stress test is also to blame. As a result of fewer uninsured deals, lenders are pricing insured deals even more aggressively.
• Non-deposit-taking lenders in particular have little choice but to drop their pants on insured mortgage rates. They don’t have deposits, or covered bonds or deposit notes as funding sources. Non-deposit-taking lenders rely heavily on securitization and that means insured mortgages are the cheapest and easiest for them to fund. They must price aggressively on mortgages they can readily fund, or die a slow death.
• The good news for insured borrowers is discounts are aggressive. Witness the prime – 1.32% variable rates on RateSpy if you need evidence of that.

It’s Good to be a MIC

• B-20 has been a bonanza for non-federally regulated non-prime lenders. They aren’t under OSFI’s thumb, so no government stress test applies.
• Many Mortgage Investment Corporations (MICs) in particular are seeing surges in business from borrowers who can no longer qualify at non-prime FRFIs, like Equitable Bank and Home Trust.
• MICs are also enjoying better-qualified borrowers—since they have more applicants to choose from. The biggest problem for MICs: a shortage of capital to lend out.

Watch those Bonds

• If the Bank of Canada dishes out two more rate hikes this year (as bond traders expect), 5-year bond yields—and by default, the stress test rate—could climb another 30-40+ basis points.
• That could shave off at least 3-5% more from the maximum purchasing power of Canadian homebuyers.

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2018 will be the year to watch in Canada’s mortgage market…