A B20 breakdown

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I suspect that by now, brokers are well aware of B20; the underwriting guidelines for Residential Mortgages that OSFI, the regulator of all Canadian Financial Institutions, has imposed on all regulated lenders and CMHC.  These underwriting guidelines have been created at the insistence of the Financial Stability Board, the financial oversight organization of all G20 nations.  The creation of these guidelines is a direct result of the financial crisis caused by poor American mortgage lending practices.

It’s essential brokers get a good overview of the situation: the components of B20 in general terms and what it means to lenders; what it means to them, the brokers; and, then, how we at Optimum Mortgage are responding.

Components of B20
The Guideline sets out what OSFI considers to be prudent residential mortgage underwriting standards.  A residential mortgage is considered to be a loan or any other product, like a HELOC, that is secured by a residential property -- up to a four-unit dwelling.  

The Guideline sets five principles for sound residential mortgage underwriting:

1.    All lenders must have a policy outlining risk appetite, governance and oversight mechanisms to ensure lenders follow their own policies.
2.    Lenders must confirm the borrower’s identity, background and demonstrated willingness to service debt obligations on a timely basis.
3.    Lenders must assess the borrower’s capacity to service their debt obligations on a timely basis.
4.    Lenders must be satisfied that the value of the property being financed has been confirmed by an independent third party.
5.    Lenders must stress test their portfolio of business for unlikely, but plausible scenarios to determine the impact to their business. Lenders are expected to impose a higher level of due diligence on higher risk deals, conduct ongoing risk assessments on the insurers they use and generally pay close attention to the risk attached to their residential mortgage portfolio.

Lastly, while not one of the principles, on a quarterly basis, lenders must now publicly disclose their book of business by insured vs. uninsured loans, amortization buckets, average LTV at origination and provide commentary on the impact on residential mortgage loans and HELOCs in the event of an economic downturn.

What Does this Mean to Brokers?
In terms of “A” business - not a lot has changed.  As I suspect is the practice now, brokers must know their client, know their client’s financial circumstances and be satisfied that their client has the ability to repay.  

For HELOC “A” clients, LTV on the HELOC portion of the advance has been limited to 65%. Brokers can still provide their clients with an 80-per cent LTV option by combining the HELOC portion with a fixed or variable portion if the HELOC product allows, such is the case with our HELOC product Homeworks.

For clients that we call alternative lending clients, including “B”, NIQ and Stated Income clients, brokers will probably have to provide a little more information.  The biggest challenge will be business-for-self (BFS) clients who do not have traditional income confirmation documents.

What Does this Mean to Optimum Mortgage?
Well in summary, not much has changed. Our previous underwriting policy was generally compliant with B20 regulations.  We are primarily an alternative lender, which is we are a BFS and “bruised credit” mortgage lender. We have always conducted due diligence to determine the borrower’s ability to make repayments. We also offer “A” residential mortgages and have a very competitive HELOCs, which is now limited to 65 per cent on the HELOC portion as a result of B20.

Prior to B20, we did not have stated TDS and GDS ratios in our alternative lending policy. Consequently, our underwriting policy will now include TDS and GDS ratio limits for our alternative lending products. These limits will be significantly higher than "A" lending requirements as our main focus will continue to be on ensuring affordability for the borrower.

B20 does state that if a lender advances a “non-conforming mortgage,” the LTV is limited to 65 per cent. At Optimum Mortgage, a non-conforming mortgage is one where a borrower has either (or both) a lower-than-average beacon score and/or the borrower’s ability to service the proposed debt cannot be confirmed to our satisfaction. Defining a non-conforming mortgage beyond this is difficult at this time.  We suggest brokers work with our business development managers and underwriters on a case-by-case basis and clarification will become evident.

In response to the challenge to confirm income levels for BFS clients who do not have traditional income confirmation documents: for the last couple of years, we have requested bank statements as a means of doing so. That will not change.  If a BFS client states he/she has income of $75,000 per annum, we would expect to see business bank statements that would suggest the business can afford to pay the borrower $75,000 annually.  We may also need to see personal bank statements, demonstrating personal income at this level. This all assumes no traditional income documents, such as tax returns, are available.  

We suggest brokers continue to ask their clients – “is this mortgage payment affordable?”  Our expectation is that brokers are satisfied that their client can afford to repay this debt and we can see in their bank statements that the debt is affordable.  
    
Summary
•    Bad underwriting practices in the USA on Residential Mortgages created a financial crisis throughout the world that has yet to be solved.  
•    These guidelines ensure lenders do not fall into the trap of doing business without appropriate consideration to risk assessment.
•    Lenders have to ensure that referring brokers conduct due diligence to satisfy themselves that they know who their client is and they have the capacity and the willingness to repay.  
•    Is this bad?  No, not at all.
•    Will this make business more difficult to conduct? Initially, but on balance, brokers should not see much difference.
•    As a broker, what can you do?  Work closely with your Underwriter and your BDM.  Remember, we all want to get the deal done, so let’s all work through these changes together.
 

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