OSFI Flags Underwriting Issues Related to Income Verification

The Office of the Superintendent of Financial Institutions (OSFI) conducted its first Annual Risk Outlook for this year and the results depict several potential issues in the housing market which has led to OSFI to outline and plan potential regulatory responses. The report published by OSFI includes an analysis on each potential aspect whether it is related to cyber-attacks and climate change to housing and corporate debt funding.

With regards to housing, the OSFI highlighted the risks that are linked with the income verification for specific types of mortgage products including rentals and self-employed borrowers. “Recent supervisory reviews identified several common issues around underwriting, specifically income verification in areas that have been raised as being problematic in the past including business for self, rentals, exceptions to income sustainability as well as collateral management,” the report reads.

OSFI further added, “Recent growth in such lending has amplified risk for lenders. Supervisory review work has revealed that lenders need additional guidance to ensure their underwriting policies align with the principles of Guideline B-20.”

Furthermore, OSFI also revealed that it is willing to consider the application of B-20 guidelines to other mortgage products including reverse mortgages, combined loans plans (CLPs), and mortgages with shared equity. This is because these types of products are becoming more prevalent due to current circumstances in the housing market. The report also highlighted that real-estate secured lending exposure for lenders has also increased because the current housing market conditions have been driven by very low interest rates and imbalances in the housing supply and demand,

Risk Weighting for Investors in Mortgages to Increase in 2023

It has been confirmed by OSFI that it will be taking direct actions against investors in mortgages through the implementation of additional rules as part of their international Basel II guidelines. Because investor-class mortgages now represent nearly one-third of recent residential home purchases, it has become the focus of OSFI as well other potential investors as well.

“… as part of the domestic implementation of the Basel III reform package in banks’ fiscal Q2-2023, we are increasing the risk weights, and thus capital required, for investor mortgages compared to the risk weights for owner-occupied properties,” the report reads.

Although it is still not clear how the specifications would translate to specific regulations, it is estimated that a higher down payment would be the result of an increase in risk-weighing as compared to owner-occupied mortgages.

In addition, OSFI also indicated that they are prepared to make changes to the stress test, or the Minimum Qualifying Rate (MQR) should the economic and market conditions warrant the change. The next scheduled review of the MQR is on December 15, 2022. “As mortgage rate edge upward on expectation of tightening monetary policy, and as the severe-but-plausible risk of a housing market downturn remains, homebuyer and lenders alike will have greater confidence to weather negative shocks with the MQR ‘stress test’,” said by OSFI in their report.