Tuesday, March 20, 2012

Proposed Guidelines, Thank You Captain Obvious

Something about having to institute guidelines that state the blindingly obvious... does make one wonder what is going on.
OSFI - Office of the Superintendent of Financial Institutions (of Canada)
FRFI - Federally Regulated Financial Institution
RMUP - Residential Mortgage Underwriting Policy

OSFI Draft Guideline
HELOC products provide an alternative source of funds for consumers. However, FRFIs should recognize that, over time, these products can also significantly add to consumer debt loads. While some borrowers may elect to repay their outstanding HELOC balances over a shorter period of time relative to the average amortization of a typical traditional mortgage, the revolving nature of HELOCs can also lead to greater persistence of outstanding balances, and greater risk of loss to lenders. As well, it can be easier for borrowers to conceal potential financial distress by drawing on their lines of credit to make timely mortgage payments and, consequently, present a challenge for lenders to adequately assess credit risk exposure.
For HELOCs, as described under Principle 4 of this Guideline, OSFI expects FRFIs to have clearly articulated amortization requirements in place for all outstanding HELOC balances. FRFI approaches should be risk-based, and better practice would consider:
• A clearly-defined period (e.g., 5 years), after which the outstanding balance of the HELOC converts to a fixed-term with a reasonable amortization period; or
• A set percentage of the outstanding balance of the HELOC due each month that equates to a reasonable amortization period.
I'm actually quite surprised that when CMHC ceased insuring HELOCs that they didn't become much more rare. Much of these guidelines is an eerie (for me) list of exactly what went wrong in the U.S.
Mortgage default insurance (mortgage insurance) is often used as a risk mitigation strategy. However, mortgage insurance should not be a substitute for sound underwriting practices by FRFIs, as outlined in this Guideline. It should not be considered a substitute for conducting adequate due diligence on the borrower, or for using other risk proxies such as the minimum down payment.
For example, a credit bureau score, offered by the major credit bureaus, is an indicator often used to support credit granting. However, a credit score should not be solely relied upon to assess borrower qualification, since these indicators measure past behaviour and do not immediately incorporate changes in a borrower’s financial condition or demonstrated willingness to service their debt obligations in a timely manner.
Maintaining sound loan documentation is an important administrative function for lenders. It provides a clear record of the factors behind the credit granting decision, supports lenders’ risk management functions, and permits independent audit/review by FRFIs and by OSFI. As well, maintaining sound documentation is necessary for lenders to demonstrate compliance with mortgage insurance requirements and ensure insurance coverage remains intact. Consequently, FRFIs should maintain complete documentation of the information that led to a mortgage approval. . . .
. . .
As a general principle, an independent third-party conducting a credit assessment of a FRFI’s mortgage loan should be in a position to replicate all aspects of the underwriting criteria, based on the FRFI’s sound documentation, to arrive at the derived credit decision.
Automated valuation tools – Where FRFIs use automated valuation tools, processes should be established to monitor their on-going effectiveness in representing the market value of the property. Controls should also be in place to ensure that the tools are being used appropriately by lending officers.
FRFIs should not structure a mortgage or combination of a mortgage and other lending products (secured by the same property) in any form that facilitates circumvention of the maximum LTV ratio limit it establishes in its RMUP. Further, the LTV ratio should not be relied upon solely as an alternative to assessing the borrower’s demonstrated willingness and capacity for repayment of the loan (see Principles 2 and 3).
Down Payment
With respect to the borrower’s down payment for both insured and uninsured mortgages, FRFIs should make reasonable efforts to determine if it is sourced from the borrower’s own resources or savings. Where part or all of the down payment is gifted to a borrower, it should be accompanied by a letter from those providing the gift ensuring no recourse. Incentive and rebate payments (i.e., “cash back”) should not be considered part of the down payment.
I like these OSFI guys/gals. Where have they been the last five years, I wonder.

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