New Mortgage Rules May Push Borrowers to Alternative Banks: RBC

(Bloomberg) -- Borrowers who don’t meet the lending criteria of Canada’s big banks for home loans may turn to credit unions and private lenders under tougher mortgage rules released by the country’s banking regulator, according to RBC Capital Markets.

While the final rules have a “very minor negative impact” to large Canadian banks, the changes are more negative for non-prime lenders such as Home Capital Group Inc. and Equitable Group Inc. due to the stress tests and ban on bundling of mortgages, RBS analysts Darko Mihelic and Geoffrey Kwan wrote in a note to clients.

The Office of the Superintendent of Financial Institutions released final rules targeting borrowers in the uninsured mortgage market, making it more difficult for those with more than a 20 percent downpayment to qualify for home loans. The measures, known as B-20 guidelines, require lenders to test a borrower’s ability to pay at the greater of the Bank of Canada’s five-year benchmark rate or 2 percentage points higher than the offered mortgage rate starting in January.

“This is likely to lead to a significant number of non-prime borrowers to either defer purchasing a home or seek out a mortgage from lenders such as credit unions/caisse populaires" and, failing that, a mortgage investment corporation or private lender, the RBC analysts wrote.

Alternative lenders fell in Toronto trading, with Equitable falling 1.6 percent and Home Capital declining 2.3 percent at 12:58 p.m. trading. Canada’s eight-company S&P/TSX Commercial Banks index rose 0.3 percent.

Dampen Incentives

The alternative lenders may see the negative impacts of the rules -- and potential loss of business -- offset if prime borrowers get turned down by banks and end up becoming their customers, RBC said.

The final rules were little changed from those the banking regulator proposed in July. One change was adding the Bank of Canada benchmark rate to the stress test criteria.

“The revision to the stress test requirement is intended to dampen incentives to take variable or shorter-term fixed rate mortgages," RBC said in its note.

Barclays Plc analyst John Aiken doesn’t expect a significant impact on banks’ lending volumes.

“What is out for debate is the impact it’s going to have on the monolines or some of the other providers,"Aiken said in an interview. “This could have an impact on overall lending volumes and then potentially have an impact on the housing market in totality."

Slow Housing

Broadening the stress test will likely further slow housing activity, depressing demand by 5 percent to 10 percent once implemented, Brian DePratto, an economist at Toronto-Dominion Bank wrote in a note. Price growth will also suffer, with the changes expected to exert a drag of between 2 percent and 4 percent over 2018.

“On balance, these changes should help enhance the resilience of the Canadian banking system in a rising interest rate environment," DePratto said.

Insured mortgages, which were already subject to the stress test, were down 4.5 percent on the year, according to OFSI data, while uninsured mortgage credit grew 17 percent. While this is partly related to the rising prices of Canadian real estate, with more and more of it priced above the insurance caps, it also likely reflects the skew stemming from the past stress test requirements, DePratto said.

To contact the reporter on this story: Doug Alexander in Toronto at dalexander3@bloomberg.net.

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, David Scanlan at dscanlan@bloomberg.net, Jacqueline Thorpe, Chris Fournier