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Mortgage regulation could spark ‘severe downturn’

This article appeared on Mortgage Business on 20/10/17, by James Mitchell.

A decision by Canada’s banking regulator to impose further restrictions on borrowers has triggered fresh fears over how markets might react to lending curbs.

This week, the Canadian equivalent of APRA — the Office of the Superintendent of Financial Institutions (OSFI) — announced fresh changes to its mortgage underwriting guidelines.

Canadian borrowers will now need to pass a “stress test” or minimum qualifying rate for uninsured mortgages.

From 1 January 2018, the guidelines will require the minimum qualifying rate for uninsured mortgages to be the greater of the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate plus 2 per cent.

Lenders will also be required to enhance their loan-to-value (LTV) measurement and limits so they will be dynamic and responsive to risk.

In addition, new restrictions will be placed on certain lending arrangements that are designed, or appear designed, to circumvent LTV limits.

The regulator said: “A federally regulated financial institution is prohibited from arranging with another lender a mortgage, or a combination of a mortgage and other lending products, in any form that circumvents the institution’s maximum LTV ratio or other limits in its residential mortgage underwriting policy, or any requirements established by law.”

The Canadian mortgage market has already been hit with a series of lending curbs similar to those that have been in place in Australia since 2015.

Yet the new credit controls come after its central bank raised the official cash rate to 1 per cent last month, following a hike in July.

Like Australia, Canada has experienced significant property price growth in recent years. In major cities like Vancouver and Toronto, 12-month gains of 30 per cent or more have not been uncommon.

Steve Eisman, the infamous fund manager featured in Michael Lewis’ book The Big Short (and played by actor Steve Carell in the Hollywood movie), believes that a “severe correction” is on the cards for Canada.

In an interview with Bloomberg this week, Mr Eisman highlighted that the Canadian housing market has risen far higher than the US market did on a percentage basis and is “ripe for a severe correction”.

“I think it will be 15 to 20 per cent down. There are regulations coming in that will be very negative for the market in terms of mortgage volumes. I think 2018 will be a very crucial year for the Canadian housing market,” the fund manager said.

Mr Eisman believes that the new regulation — which will make it harder for Canadians to obtain housing finance — could be the trigger.

Fears over how Canada’s property market will cope with the new lending curbs have led an Australian mortgage industry veteran to question how macro-prudential measures in this country could reshape the lending landscape.

“When a bank regulator perceives a risk to the stability of the banking system, there’s always a chance that they will take dramatic action,” GlobalED executive chairman Kym Dalton told Mortgage Business.

“While I’m not signalling that APRA is contemplating macro-prudential activity of this type, brokers and lenders should be aware that continuing house price appreciation and affordability issues may lead to regulatory outcomes that could impact housing values and mortgage market volumes.”

Regulators often take their cues from their international counterparts, and the macro-prudential trend has been a global one. In the Reserve Bank of Australia’s most recent Financial Stability Review, released this week, an analysis of international housing market risks focused on Canada’s use of lending curbs.

“Overall, available evidence suggests that a range of policies (including both macro-prudential and other tools) have led to some improvement in household and banking sector resilience in several markets,” the RBA said.

“However, household debt levels and housing prices remain high and continue to grow rapidly in many regions, so risks persist. Macro-prudential policies can at best moderate the growth of credit and prices for a while, but they cannot address the high levels of debt and prices.

“Further, there continues to be much uncertainty around the calibration and effectiveness of these tools. Ongoing analysis and experience will be important for understanding the impact that such policies can have on housing market risks.”