On June 21, 2012, the Office of the Superintendent of Financial Institutions (OSFI) released the final version of Guideline B-20 – Residential Mortgage Underwriting Practices and Procedures (Guideline B-20). (For further details, see our June 2012 Blakes Bulletin.) Guideline B-20 applies to all federally regulated financial institutions (FRFIs) engaged in residential mortgage underwriting and/or the acquisition of residential mortgage loan assets in Canada. Coupled with the announcement from the Minister of Finance reducing the maximum amount Canadians can borrow when refinancing and reducing the maximum amortization period, Guideline B-20 is part of a larger effort to strengthen Canada's housing finance system.
Summary of Guideline B-20
Guideline B-20 sets out five fundamental principles for prudent residential mortgage underwriting. These principles are summarized in more detail in our March 2012 Blakes Bulletin. While the principles are generally the same as set out in the Draft Guideline B-20 published in March 2012 (the Draft Guideline), Guideline B-20 reflects some of the comments made by FRFIs during the consultation period and modifies or eliminates certain requirements. A summary of the consultation comments and OSFI's responses was published alongside Guideline B-20.
Principle 1: FRFIs that are engaged in residential mortgage underwriting and/or the acquisition of residential mortgage loan assets should have a comprehensive Residential Mortgage Underwriting Policy (RMUP). Residential mortgage practices and procedures of FRFIs should comply with their established RMUP.
The RMUP should be based on the limits provided in a Board-Approved Risk Appetite Framework (Framework). The requirements for such a Framework will be set out in a revised version of OSFI guideline Corporate Governance Guideline which is still to be published. The factors originally identified in the Draft Guideline that should inform the RMUP are unchanged, but OSFI has clarified that risk management practices and processes should be considered at the portfolio level whereas acceptable underwriting and acquisition standards, criteria and limits for residential mortgage loan products should be considered at the individual residential mortgage loan level.
Guideline B-20 provides greater detail regarding OSFI's expectations of the board of directors of an FRFI (the FRFI Board) than previously found in the Draft Guideline. An FRFI Board is expected to review and discuss the RMUP and any changes thereto. Further, the FRFI Board must understand the actions of Senior Management with respect to residential mortgage underwriting and/or acquisition of residential mortgage loan assets and their potential impact on the FRFI. It is unclear how OSFI will monitor compliance with this requirement. The forthcoming revised Corporate Governance Guideline may provide more information, but in the meantime FRFI Boards should take care to document communications with Senior Management that demonstrate the FRFI Board has "probe[d], question[ed] and [sought] assur-ances from Senior Management" on mortgage matters.
Principle 2: FRFIs should perform reasonable due diligence to record and assess the borrower's identity, background and demonstrated willingness to service his/her debt obligations on a timely basis.
Generally unchanged since the Draft Guideline, Principle 2 requires FRFIs to undertake and document, in detail, the due diligence that supports the conclusion that the borrower can service and repay the loan in accordance with its terms. Guideline B-20 identifies some of the information that FRFIs must gather at the origination of the mortgage, at any subsequent refinancing and "periodically" in between those events, in particular if the borrower's condition or property risk changes materially. While the meaning of "periodically" is not certain, it is clearly not sufficient to update borrower's credit metrics only at renewal. Going forward, OSFI expects FRFIs to articulate their renewal procedures, including the requisite due diligence, in internal policies governing their underwriting of residential mortgages.
Principle 3: FRFIs should adequately assess the borrower's capacity to service his/her debt obligations on a timely basis.
This principle identifies key factors that should assist FRFIs when evaluating a borrower's capacity to service their debt obligations without undue hardship. Unlike the Draft Guideline, Guideline B-20 does not specifically recommend FRFIs pursue the income tax information of borrowers and no longer requires FRFIs to disclose the rationale for the qualifying rates applied in their assessments. Guideline B-20 also does not offer guidance with respect to how the fact that a particular loan extends past normal retirement age should affect the assessment.
As mentioned in the Interim Update on Draft Guideline B-20, Guideline B-20 does not require FRFIs to have clearly articulated amortization requirements in place for all outstanding Home Equity Line of Credit (HELOC) balances. HELOCs at or below a loan-to-value ratio of 65% do not need to be amortized. This better reflects the intent of those consumers who need revolving lines of credit than the Draft Guideline which previously indicated all HELOCs would need to be amortized.
The Accompanying Letter also states that Guideline B-20 will not apply on a retroactive basis to those residential mortgages already in place. Accordingly, existing HELOCs with a loan-to-value ratio in excess of 65% will not be affected. FRFIs may see increased demand from consumers seeking to obtain such HELOCs before compliance with Guideline B-20 is strictly required.
Principle 4: FRFIs should have sound collateral management and appraisal processes for the underlying mortgage properties.
OSFI maintained its position set out in the Draft Guidelines with respect to the collateral management and appraisal processes for underlying mortgage properties. However, Guideline B-20 emphasizes that FRFIs cannot rely on any single method for property valuation. This is consistent with the "holistic, risk-based approach" OSFI recommends FRFIs undertake when making their evaluations. Accordingly, the valuation tools and appraisal processes identified in Principle 4 should not be assumed to be exhaustive. FRFIs will have to carefully consider the combination of such tools and processes, as well as other tools available, that are appropriate on a case-by-case basis.
OSFI also removed the comment that FRFIs should not use title insurance or valuation insurance as a substitute for sound appraisal or valuation processes, suggesting that OSFI will consider the presence of title or valuation insurance to be a legitimate, albeit not sufficient, factor to consider when evaluating the risk presented by a particular property.
Principle 5: FRFIs should have effective credit and counterparty risk management practices and procedures that support residential mortgage underwriting and loan asset portfolio management, including, as appropriate, mortgage insurance.
Since publication of the Draft Guidelines, OSFI clarified that Guideline B-20 only applies to mortgage originators (or acquirers) and not mortgage insurers. As a result, unlike the Draft Guideline, Guideline B-20 does not require FRFIs that underwrite mortgage insurance to conduct their own level of due diligence on the mortgage underwriting criteria and risk management of the lender. However, a separate draft guideline applicable to mortgage insurers is expected to be published for consultation in the near future. Mortgage insurers should expect the forthcoming draft guideline to set out due diligence requirements that complement Guideline B-20.
Guideline B-20 sets out several disclosure requirements applicable to FRFIs. Among other things, FRFIs must publish the amount and percentage of the total residential mortgage loans and HELOCs that are insured or uninsured, the percentage of residential mortgages that fall within certain amortization periods, the average loan-to-value ratio for newly originated and acquired uninsured residential mortgages and HELOCs, and a discussion of the potential impact on residential mortgage loans and HELOCs in the event of an economic downturn. FRFIs must publish such disclosure quarterly and "in a format and location that will support public availability and understandability".
Unlike the Draft Guideline, Guideline B-20 does not explicitly require FRFIs to publish the average Total Debt Service (TDS) and Gross Debt Service (GDS) ratios for newly originated and acquired residential mortgages and HELOCs, a description of the primary credit quality indicators used to assess and monitor credit quality and the rationale behind the qualifying rate used in GDS and TDS calculations. However, OSFI does not intend that the items identified in Guideline B-20 are exhaustive and some FRFIs may find it appropriate to provide this information as well.
Timing for Compliance
OSFI expects FRFIs to be in full compliance with Guideline B-20 by the end of fiscal year 2012. However, in the Accompanying Letter, OSFI states "where possible, FRFIs should comply with the principles and expectations set out in the Guideline as of [June 21, 2012]". FRFIs should not expect any leniency when OSFI begins monitoring compliance with Guideline B-20 and those who have not already begun to plan for their implementation of Guideline B-20 and conduct self-assessments of compliance should do so immediately.
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