Stress testing private mortgage lenders raises questions of effectiveness, regulation

A report that the federal government is considering expanding its mortgage stress-testing rules to cover private lenders is raising concerns that the change could be difficult to enforce and would not necessarily curb dangerous lending practices.

A Reuters report Friday cited unnamed sources who said officials from the federal Finance Department, the Office of the Superintendent of Financial Institutions (OSFI), the Bank of Canada and Canada Mortgage and Housing Corp. held confidential talks about the idea of requiring unregulated private lenders to follow the same mortgage stress-testing rules that were introduced for Canada’s chartered banks and other federally regulated mortgage lenders on Jan. 1, 2018. (All the organizations declined to comment Friday on the report.)

The report said regulators are concerned about the amount of new business flowing to private lenders, who typically charge higher interest rates and lend to higher-risk investors. A Bank of Canada report in November, for example, said the market share of private mortgage lenders in the Greater Toronto Area had climbed to 9 per cent in the second quarter of 2018 from 6 per cent a year earlier.

The Reuters report said one option is that federal regulators could ask each province to adopt stress-test-style rules for private lenders. They could alternatively ask provinces to ensure that private lenders run tighter checks without imposing the actual stress test, the report said.

It is unclear, however, how provinces would enforce any new lending rules on an unregulated sector.

A source who is familiar with the options under consideration told The Globe and Mail Friday that one option could be to limit the ability of lenders to register mortgage claims with provincial land-title offices unless they follow the new rules. The source was granted anonymity by The Globe because they were not authorized to discuss the matter publicly.

But Paul Taylor, chief executive officer of Mortgage Professionals Canada, an industry group for the mortgage lending profession, said such a move seems “incredibly overly complicated.”

He predicts that it would be difficult to get all the provinces to agree to harmonize new rules on private lenders, especially if the solution is to require land-title office staff to become monitors of lending practices. “The land registries would end up having to become mortgage auditors and validate things like letters of employment and appraisals of property − it would be a tremendously different function for the land registry than it is currently.”

It would also become unnecessarily burdensome if private individuals who want to lend money to a friend or family member had to apply a stress test, Mr. Taylor said.

Mr. Taylor is also not convinced that a move to apply a stress test to private lenders would make a major difference in reducing risk in the lending system. Private lenders often charge 10 per cent to 13 per cent on a mortgage loan, he said. An additional two-percentage-point mortgage stress test, he added, becomes a more marginal extra burden than it is for a conventional borrower paying a 3-per-cent mortgage rate.

“It’s almost useless as an exercise,” he said. “When you consider the interest portion of a payment at 13 per cent and then do the math at 15 per cent, the proportion of the increase is actually not that big of a difference.”

If the federal government wants to reduce the proportion of borrowers going to private lenders, Mr. Taylor said it would be far easier to simply ease up the stress-test rule a bit so more qualify with regulated lenders.

Dan Eisner, CEO of True North Mortgage, whose clients are typically subject to the existing stress test, said private lenders would not be considered structurally important to the banking system since they do not hold client deposits. There would be no meaningful knock-on impact or run on a bank if a private lender comes under stress, he said.

At the same time, any new rules would have an immense impact on the business of private lenders.

“The primary reason people go to private money is because they don’t have sufficient income to pass a bank stress test, so a stress test could literally eliminate any of this private money,” Mr. Eisner said. “If the client could pass a stress test, they would likely go to RBC or any other prime lender.”

Geoffrey Kwan, an analyst at RBC Dominion Securities Inc., said Friday that it is unclear whether such a new rule would also apply to mortgage investment corporations (MICs), which provide mortgage loans and are registered with provincial securities commissions. MICs are not regulated by OSFI, Canada’s banking regulator, so do not currently have to apply the stress-test rules.

He said targeting MICs could be easier because they are already subject to some regulation, but it would be harder to regulate other private lenders unless land-registry offices were involved in the process. He added that it is unclear what it would cost to set up a monitoring system with registration, auditing and compliance checks on private lenders.

But Benjamin Tal, deputy chief economist at CIBC World Markets Inc., said Friday that he thinks the government should look at expanding the stress test to private lenders because of the risk to the financial system if they follow poor practices.

“In many ways, we’re transferring risk from the regulated segment of the market to the least-regulated segment of the market,” he said. “We’re transferring risk from where it is light, to where it is dark. And that’s suboptimal.”

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