Well…we may as well get right to it. The Treasury Guy is in no mood for frivolity today. If you are a mortgage lender or borrower and haven’t been on Mars this week, you know that the Minister of Finance announced a number of changes designed to ‘reinforce the Canadian housing finance system’ on Monday…on Rosh Hashanah no less!
In case you haven’t already seen the details, here are the key changes:
Mortgage Rate Stress Test
To qualify for mortgage insurance the Gross Debt Service Ratio (“GDS”) cannot exceed 39%. GDS is the percentage of your monthly household income that covers housing costs including mortgage payments, property taxes, heating expenses, and half of the condo fees (if applicable). Effective October 17th, all insured homebuyers must meet debt service ratios calculated using the Bank of Canada 5 year posted rate (the “Qualifying Rate”), which is currently 4.64% (as compared to the current actual or ‘contract’ 5 year rate around 2.44%). To put this change in context, a borrower that qualified for a 5 year insured mortgage of $300,000 with a GDS of 39% last week would only qualify for about $240,000 this week. That’s a 20% decrease.
According to Genworth, as many as one third of high ratio insured mortgages, predominantly for first time homebuyers, would have difficulty meeting the required debt service ratios and homebuyers will need to consider buying a lower priced property, or be forced out of the market entirely.
Changes to Low-Ratio Insurance Eligibility Requirements
Effective November 30th, mortgage loans that lenders insure using portfolio insurance must meet eligibility criteria that previously only applied to high ratio mortgages. New criteria for low-ratio mortgages to be insured include the following:
- A loan whose purpose includes the purchase of a property or subsequent renewal of such a loan;
- A maximum amortization length of 25 years;
- A maximum property purchase price below $1,000,000;
- A minimum credit score of 600;
- A maximum GDS ratio of 39% and a maximum TDS ratio of 44% calculated by applying the greater of the mortgage contract rate or the Bank of Canada Posted Rate (the “Qualifying Rate”);
- A property that will be owner occupied.
Perhaps most significant among the changes is the implication that mortgages related to refinancing activity will not be eligible for insurance, and by extension, will be not be eligible for CMHC securitization programs including NHA MBS and the Canada Mortgage Bond. The changes may affect as much as 50% of conventional mortgage origination.
Since we’re talking about portfolio insurance, it might be worth mentioning the new capital framework for mortgage insurers drafted by the Office of the Superintendent of Financial Institutions (“OSFI”). The short story is that default insurers will need to hold a lot more capital. A LOT MORE. The comment period for the draft advisory ends on October 21st and finalized changes will come into force on January 1st 2017. If you’re looking for something to do this weekend, feel free to draft some angry comments to OSFI. Whatever the final form takes, one outcome is certain. Mortgage default insurance premiums are going to be higher. A LOT HIGHER. In the case of low-ratio portfolio insurance (at least for the mortgages that are still eligible) as much as 2-3 times higher. Mortgage rates will almost certainly need to be higher too.
The impact on the CMHC multi-family space is not clear. If the changes related to eligibility for insurance are implemented through amendments to the Eligible Mortgage Loan Regulations and Insurable Housing Loan Regulations, which apply to ‘single family residential mortgages’, then multi-family borrowers may be unaffected and insured refinancing may still be available and access to CMHC securitization programs will continue. It’s too soon to say for sure though, so we’ll keep you posted. Unfortunately, it’s unlikely that multi-family insurance premiums will escape the impact of the new capital framework. Costs are definitely going up.
Forthcoming Consultation on Lender Risk Sharing
And the hits just keep coming…The Government also announced that it is reviewing the potential for some form of risk sharing such that lenders would retain some level of exposure to mortgage default risk on insured mortgages. One example would be a deductible on insurance proceeds. The public consultation process on this proposed change will take some time. The potential impact is unclear at this time, but the theme of higher capital requirements is sure to persist. The cost of borrowing will be higher.
One interesting outcome from the announcements on Monday has been a sharp contraction in NHA MBS spreads. Some market participants believe that the stricter rules for lending and the higher requirements for mortgage insurance could reduce mortgage origination and in turn lower sales of mortgage backed securities. I’ll take the lower spreads as a modest silver lining.
In the equity markets, First National’s stock took a hit as the market hit the panic button and sold non-bank lenders and ‘alternative’ lenders like Home and Equitable indiscriminately. FN closed at $25.60 yesterday, down $6.37 or almost 20% on the week. I won’t comment much on this…I’m not really sure how much I can say and Treasury Guy would not do well in prison, but if you read things like our annual statement, you’d see that half of our origination is funded by mortgage sales to large balance sheet investors who do not insure or securitize the conventional mortgages they buy from FN. That’s all I’ll say about that. On the plus side, our dividend yield is now 6.67%...so we’ve got that going for us.
With respect to monetary policy, the application of the new Qualifying Rate is like a focused 2.20% rate hike applicable only to the mortgage market since many borrowers will now have to qualify at 4.64% rather than the prevailing market rate of 2.44%. The elimination of amortizations higher than 25 year for low ratio insurable loans will also force monthly payment higher. Bottom line is that housing ‘affordability’ is reduced and the Bank of Canada might have a little more wiggle room to cut rates without fear of further stoking the housing market.
After the events of this week, I will try to remember the following Zen philosophy this weekend:
“Backwards spelled forward is backwards”.
KEEP CALM & CARRY ON. (Go Jays).
Jason Ellis, Managing Director, Capital Markets