The Office of the Superintendent of Financial Institution’s new regulations governing underwriting practices — set to take effect at the beginning of next year — have been the source of much acrimony in the mortgage industry, and some are wondering if the federal government is deliberately sabotaging some lenders to benefit large banks.

Two industry veterans echoed each other in stating that certain lenders, like mortgage finance companies, will not be able to keep their heads above water.

Additionally, both not only questioned why credit card debt isn’t a topic of conversation if household debt is, indeed, reaching disquieting levels, but they both believe many first-time homebuyers will be precluded from entering the housing market.

Before the latest regulation amendment, the Department of Finance updated lending practices in October 2016.

“I thought last year’s changes were more than enough,” said Fisgard’s Senior Vice President of Residential Mortgage Investments & Broker Relations, Hali Strandlund-Noble. “The problem I have with that is I’m a believer that household debt being on a mortgage is something tangible. Why are they not dealing with unsecured lines of credit, credit cards at 19.99%-plus? There’s no talk about that, no talk about qualifying those people. That’s a big concern of mine. I’m okay with healthy mortgage debt.”

While Strandlund-Noble agrees that housing prices in Vancouver and Toronto need to come down, she’s confounded by the government’s one-size-fits-all policy because she sees small cities and first-time buyers being pilfered. Atlantic Canada and the Prairie provinces are among large swaths in which she sees trouble brewing.

“I would love to see [the federal competition bureau] step in and take a look,” she said. “I would have thought they would have stepped in by now, and if they don’t step in this time, especially with how it’s affecting monolines and mortgage finance companies, I don’t think they will. It’s very disappointing.”

Asked how precarious the rule changes will be for consumers, Strandlund-Noble said, “I don’t know if ‘precarious’ is the right word. It’s lack of opportunity to become a homeowner at this particular time in their life cycle of buying, selling or renting. Many will have to wait, save and maybe even get rid of some credit cards. There’s a lack of opportunity, definitely for first-time homebuyers. It’s hard enough for them to get in.”

David Mandel, president of First Source Mortgage, concurred with Strandlund-Noble about the government needing to rein in credit card companies “as opposed to telling Canadians how much they should spend on a home and where they should live.”

But Mandel also blames the government for the astronomical cost of housing because they did precious little to solve the supply issue. Given the government’s immigration policy, he believes they exacerbated the supply problem by not ensuring enough inventory was available in the marketplace.

“If you’re going to maintain a policy of steady immigration and bring in 300,000 people annually, most of whom will try to settle in the GTA, you need to deal with the supply of developable land and remove the red tape associated with change-of-use of existing lands so that builders and developers can readily convert or create infill projects to meet demand through higher density,” he said.

This can create more urban sprawl —which would be at odds with growth plans — he added.

Mandel ultimately believes lenders and consumers are getting fleeced by government policy that he says is convoluted enough to fly beneath the average Canadian’s radar.

“The banks are going to win huge at the expense of the monolines, and what we see, ultimately, that nobody is talking about, is further concentration in the banking industry in Canada,” he said. “There’s no competition for them.
Unfortunately, I think that’s anti-Canadian, anti-North American, and it’s anti-competitive — and that’s wrong. I think Canadians are getting a raw, raw deal and I think it’s a little too sophisticated and widespread for the average person to understand.”

Canada’s central bank is not worried that people will expect very low inflation to continue because it has repeatedly fallen short of the Bank of Canada’s 2% target, governor Stephen Poloz said on November 7.

“As a central banker you always concern yourself with…the risk that expectations will gravitate towards the actual experience instead of to the target itself,” he told The Canadian Press after discussing inflation with a Montreal business audience.

But he noted that there is no evidence of a “de-anchoring” of expectations, saying all of the bank’s surveys suggest a strong knowledge about the 2% target established 25 years ago following a period of high and volatile inflation and interest rates.

While the bank has an inflation target range of between 1% and 3%, Poloz isn’t overly concerned if it dips below or rises above the midway point. He said many advanced economies have faced a similar trend.

Read more: Household income prospects not looking up

In a luncheon speech to CFA Montreal and the Montreal Council on Foreign Relations, Poloz said the fundamental drivers of supply and demand, as well as short-term factors, can explain the movement in prices and that the popular perception that inflation has become inexplicable is exaggerated.

“In part this perception reflects a misunderstanding of the accuracy with which economists can predict inflation and a misunderstanding of the precision with which central banks can control it,” he told an audience of 1,000.

Inflation in Canada slowed over the first half of this year and remained in the lower half of the Bank of Canada’s target range even as the economy grew quickly.

The Bank of Canada is aiming to keep inflation at 2% by making changes to its key interest rate target. Poloz said it would take 18 to 24 months for a change in interest rate policy to have its full impact on inflation.

In keeping the rate on hold last month, the Bank of Canada said less monetary policy stimulus will likely be required over time, but that it will be cautious in making future adjustments to the policy rate and be guided by the incoming economic data.

“A lot of pieces need to fall into place before we can be certain that the economy has made it all the way home,” Poloz said.

The expected slowdown in the Canadian labour market did not materialize in October as full-time jobs surged and wage gains accelerated. Total employment increased by 35,300 last month and the unemployment rate rose a tick to 6.3% as the labour force participation rate edged up a bit to 65.7%–well above the level in the U.S. Full-time jobs rose 88,700 while part-time jobs fell by 53,400–evidence of strong improvement in the quality of net-new job creation. Canada has added 201K full-time jobs in just the past two months, the strongest two-month performance on record (see chart below). This report might force the Bank of Canada to reconsider its view that there remains a lot of slack in the Canadian jobs market.

Another sign of stellar growth was the 2.7% year-over-year gain in total hours worked and hourly earnings of permanent employees increased by a whopping 2.4% last month, the strongest annual wage growth since April 2016 (see the second chart below). The jobless rate has trended downward over the past year, falling 0.7 percentage points. While the overall unemployment rate was 6.3% last month, the jobless rate for prime workers–those aged 25- to 54-years old is much lower–posted at 5.1% for women and 5.6% for men. Men have been harder hit in both the U.S. and Canada as much of the restructuring in jobs has been in male-dominated industries such as heavy manufacturing (and construction in the U.S.) and most of the growth has been in female-dominated services such as health care-related services.

Canadian employment rose in several industries, led by “other services” (which include services such as those related to civic and professional organizations, and personal and laundry services) up by 21,000. Construction jobs rose by 18,000 in October but were virtually unchanged on a year-over-year basis. Also strong were information, culture and recreation and agriculture. Employment declined in wholesale and retail trade.

According to StatsCanada, the most significant employment gains were in Quebec, followed by Alberta, Manitoba, Newfoundland and Labrador, and New Brunswick. At the same time, there was a decline in Saskatchewan. Unemployment rates by province are in the table below.

October Payrolls Data in the U.S.

U.S. employers added 261,000 jobs in October, and the unemployment rate fell to 4.1% according to data released this morning by the Labor Department. As well, average hourly earnings rose 2.4% from a year earlier. Last month’s job gains mark the 85th straight month of U.S. job growth, the longest such streak on record, as the economy rebounded from the hurricane-induced slowdown in September.

The policymakers at the U.S. central bank decided to leave the target range for the federal funds rate (equivalent to the Bank of Canada overnight rate) unchanged at 1 to 1-1/4 percent, acknowledging that the stance of monetary policy remains accommodative.

This stance will allow the labour markets in the U.S., which are already very close to full employment, to continue to improve and return inflation, which has been below target, to a sustained level of 2 percent.

Unlike the Bank of Canada that has the single objective of 2 percent inflation, the Federal Reserve has two objectives–to maximize employment and 2 percent inflation. Historical data suggests that these two objectives are typically at odds–the higher the level of employment, the higher the level of inflation– so the Fed has a balancing act.

In recent history, however, inflation has remained well below target, despite the strong performance of the U.S. jobs market. The same is true in Canada. Inflation of goods and services has been held down by technological innovation, improved productivity and global competition.

Wage and salary inflation is also quite muted, especially in Canada. As well, inflation expectations are well anchored at low levels. In consequence, the economy has been able to move closer to full employment than in the past without triggering inflation, which is good news.

The policy-setting committee “expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data”.

 So, more rate hikes are ahead, but rates will rise gradually. Also, the Fed continues to unwind quantitative easing by selling bonds from its portfolio. This “balance sheet normalization program” was initiated in October 2017 and “is proceeding”.

Financial markets are interpreting the Fed’s statement as signaling that a December rate hike is on track, as the Fed acknowledged that: the economy is strong despite the hurricanes, the labour market has continued to strengthen, and it expects inflation to rise gradually. A December interest rate increase would be the third such move this year. The Fed has increased interest rates four times since late 2015, all of which happened at meetings that were accompanied by a press conference, which occurs at alternating meetings. There will be a press conference in December.

New Fed Chair

Of great interest is President Donald Trump’s nominee for the head of the central bank, a decision he is expected to announce tomorrow. According to many media outlets, the president is leaning toward picking Fed Governor Jerome “Jay” Powell, although he has been considering other candidates including the incumbent, Janet Yellen, whom he called “excellent”.

Powell, a Republican and former Treasury official, has supported Yellen’s policy of gradual rate increases, while calling for a modest rollback of post-crisis financial regulation. In more than 40 FOMC votes since becoming a governor in 2012, including this meeting, he has never dissented from the majority opinion.  

While home prices continue to rise nationally the affordability gap won’t be solved by wage rises.

The Conference Board of Canada says that average pay for non-unionized employees is projected to be 2.4% in 2018, slightly up from the 2.2% actual increases seen in 2017.

Those working in pharmaceuticals and chemical products are expected to lead the wage rises with 2.7% while those in the health sector will see just 1.6% more.

“While the Canadian economy is firing on all cylinders this year, growth projections for next year and beyond show a slowing down of the economy. As a result, business leaders continue to exercise caution, keeping a cap on organizational spending and, by extension, salary increases,” said Allison Cowan, Director, Total Rewards Research, The Conference Board of Canada.

Regionally, Manitoba, Ontario, and Quebec lead the pack in terms of projected increases, with wage gains ranging from 2.6% to 2.5%.  Meanwhile, the lowest average base pay increases are expected in Alberta and Saskatchewan, at 2.1%.

BOC Will Raise Rates Only Cautiously

The Bank of Canada held overnight interest rates at 1.0% following two consecutive rate hikes at the July and September meetings. It was widely expected that the Bank would take a breather this round. The central bank also released its quarterly Monetary Policy Report (MPR) today, in which it forecast that growth would be 3.1% this year, 2.1% in 2018 and 1.5% in 2019. The rapid pace of economic growth over the past four quarters surprised the Bank on the high side. Going forward, the Bank forecasts GDP to moderate to a more sustainable pace.

Exports and business investment are expected to contribute to growth over the forecast horizon. In contrast, “housing and consumption are forecast to slow in light of policy changes affecting housing markets and higher interest rates.” The Bank went on to say that “because of high debt levels, household spending is likely more sensitive to interest rates than in the past.” I would go one step further and suggest that higher sensitivity to interest rates is all the more so because of the OSFI stress testing of borrowers at 200 basis points above current contract mortgage rates.

The central bank continues to expect global growth to average roughly 3.5% over the 2017- 2019 period, noting that uncertainty remains high regarding geopolitical developments and fiscal and trade policies. Notably, the renegotiation of NAFTA will have a meaningful impact on the economies of North America, but given the uncertainty, the Bank economists have left this factor out of the base case projection.

Measures of core inflation have edged up as expected, but the Bank now forecasts that inflation will rise to 2% in the second half of 2018, which is a bit later than anticipated in the July MPR reflecting the recent strength in the Canadian dollar.

Business investment contributes to increases in capacity and productivity; hence the Bank of Canada now assumes that annual growth of potential output is 1.5% over 2018-19, which is slightly above the assumption since April 2017. How fast the economy can grow without triggering inflation is a big issue these days. The central bank will publish a full reassessment of this critical point in April 2018. The higher the level of potential growth, the lower the estimated level of the “neutral” nominal policy rate–the level of the overnight rate that is consistent with the Bank’s target of 2% inflation. The Governing Council of the Bank of Canada now estimates the neutral rate to be between 2.5% and 3.5%. The Bank’s economic projection is based on the midpoint of this range– 3.0%. In other words, the Governing Council of the Bank of Canada estimates that it will ultimately raise the policy rate from the current level of 1.0% by 200 basis points to 3.0% once the economy is at full employment. That is a substantial proportional jump in rates, which would undoubtedly slow interest-sensitive spending, and nothing is more interest-sensitive than housing. Which makes you wonder why the financial institutions’ regulator (OSFI) has been so intent on further tightening mortgage credit conditions.

The tone of today’s policy statement was decidedly more dovish–cautious about future rate hikes–than in July and September. Why is that? Firstly, the Bank came under a good deal of criticism for hiking rates more rapidly than expected, reversing the two rate cuts implemented (unexpectedly) in 2016. Secondly, the Bank sees significant risks to the outlook. These risks are delineated in the MPR as follows:
• A shift toward greater protectionist trade policies in the U.S. that weaken Canadian exports
• A more substantial impact of structural factors (Internet, digitization, robots) and prolonged excess supply on inflation (higher potential growth)
• Stronger real GDP growth in the U.S. (owing to prospective deregulation and tax cuts)
• Stronger consumption and rising household debt in Canada
• A pronounced drop in house prices in overheated markets

The Bank of Canada sees the risks to the inflation outlook as balanced–in other words, it is just as likely for inflation to move above forecasted levels as below them. Hence, the Bank will be cautious in raising interest rates in the future and their actions will be data dependent. In their words, “while less monetary policy stimulus will likely be required over time, Governing Council will be cautious in making future adjustments to the policy rate. In particular, the Bank will be guided by incoming data to assess the sensitivity of the economy to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation. “

The Canadian economy has grown at a stronger-than-expected annual rate of 3.7% in the past year, taking the jobless rate down to its lowest level in nearly a decade. With Canada’s economy the strongest in the Group of Seven countries, Ottawa now projects much smaller deficits than it did in March. The Liberal government cut its deficit projection for the fiscal year that ends March 31 to just under $20.0 billion, down from $28.5 billion in the March budget. It now expects a cumulative deficit over the coming five fiscal years of $86.5 billion, compared with $120 billion previously.

Finance Minister Bill Morneau announced new spending today totalling $7.7 billion over six years, bringing the total new spending since the March budget to $19.1 billion over six years. This additional stimulus comes as the economy is running far faster than its long-run potential noninflationary pace, rapidly approaching full capacity. The Bank of Canada has already raised interest rates twice since the summer and meets again on Wednesday. While we do not expect the Bank to hike rates tomorrow, additional fiscal stimulus runs the risk of ever tighter monetary policy–meaning higher interest rates than otherwise would be the case down the road. Higher interest rates slow interest-sensitive spending and nothing is as sensitive to rates as home purchases. With all the government’s concern about the record level of household debt, tighter monetary policy might well be welcome.

The government has already taken repeated actions to slow the housing market. Most recently, the federal financial institutions’ regulator, OSFI, has tightened the stress testing for non-insured mortgage borrowers effective in January.

Deficit spending, particularly the enhanced child benefit system, has undeniably been fueling consumption. The government announced today it would index its marquee Canada Child Benefit to inflation beginning in July 2018, two years earlier than scheduled. It also expanded the Working Income Tax Benefit, which supplements the earnings of low-income workers, starting in 2019. It also reduced the small business tax rate to 10%, announced last week, and it snuck in changes to the tax system that “ensure low corporate tax rates go towards supporting businesses, not to the top 1% of income earners”. In that regard, Ottawa is proceeding with a new tax on investment income held in private corporations and will detail the measure in its 2018 budget.

Trudeau’s team has been backtracking on a trio of tax proposals unveiled by Morneau in July and offered new details in its update on Tuesday. It will proceed to restrict so-called income sprinkling — paying family members who don’t work for a firm — with new legislation due later this year. The Liberals will also tax investment income held in private corporations when it exceeds $50,000 annually, releasing rules for that in its 2018 budget. It has abandoned a third proposal, which changed capital gains rules.

Despite the improved economic outlook, there is no forecast to return to budgetary balance, although the debt-to-GDP ratio does fall more rapidly than in the 2017 budget.

OSFI has published its update for the tightening of mortgage lending regulations known as Guideline B-20 and set the date that it will apply.

The revised Residential Mortgage Underwriting Practices and Procedures will take effect from January 1, 2018 and include several key changes that the regulator says is part of its expectation that federally-regulated mortgage lenders remain vigilant in their underwriting practices.

• Stress test – 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 +2%.
• Enhanced LTV measurement – federally regulated financial institutions must establish and adhere to appropriate LTV ratio limits that are reflective of risk and are updated as housing markets and the economic environment evolve.
• Restriction of certain lending arrangements –  federally regulated financial institutions 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.

“These revisions to Guideline B-20 reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada,” said Superintendent Jeremy Rudin.

The full guideline update is available from the OSFI website.

Canada’s banking regulator has published the final changes to its guidelines for residential mortgage underwriting, including a financial stress test for buyers who don’t need mortgage insurance.

The Office of the Superintendent of Financial Institutions said Tuesday the changes will come into force by Jan. 1, 2018.

Even homebuyers who don’t require mortgage insurance because they have a down payment of 20 per cent or more will have to prove they can continue to make payments if interest rates rise.

Other changes include restrictions on co-lending, or bundled mortgages, aimed at ensuring financial institutions do not circumvent rules that limit how much they can lend.

The final guidelines are generally similar to what OSFI had proposed in July, when the regulator put out a draft for public consultation.

The proposed changes, however, have been criticized for including potentially increasing costs and limiting access to mortgages for some home buyers.

“These revisions to Guideline B-20 reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada,” said Superintendent Jeremy Rudin in a statement on Tuesday.

Another organisation has added its voice to those opposing OSFI proposals to introduce tougher lending restrictions for uninsured mortgages and warns it could harm competition in the mortgage industry.

The Fraser Institute says that requiring a stress test with a margin of 2 percentage points above the agreed rate for those homebuyers with at least a 20% downpayment, is unnecessary and could negatively affect buyers across Canada.

In a study called Uninsured Mortgage Regulation: From Corporate Governance to Prescription, author Neil Mohindra says there are several potentially negative effects from the proposed rule-tightening:

Access to mortgages may become more limited, especially for buyers in high-price markets;

Buyers may be forced to abandon preferred homes for less-desirable options;

Increased use of unregulated lenders with higher interest rates;

Buyers may opt for shorter term variable rate loans.

The report also suggests that the mortgage industry could become less competitive from the OSFI rule as those lenders that are niche players in the residential market may find their business is impaired.

This, the report concludes, runs counter to the federal government’s objective of promoting more competition from smaller lenders.

“OSFI’s emphasis on corporate governance worked well during the financial crisis. Shifting towards more prescriptive rules is an ominous sign,” Mohindra said.