OSFI has released a draft of Guideline B-21 - Residential Mortgage Insurance Underwriting Practices and Procedures (the Draft Guideline), which sets out expectations for prudent residential mortgage insurance underwriting and related activities. The Draft Guideline articulates six fundamental principles for sound residential mortgage insurance underwriting and addresses disclosure and supervisory requirements. Guideline B-21 will apply to all federally-regulated mortgage insurers (FRMIs) that provide mortgage insurance for residential mortgage loans in Canada and/or reinsurance for such insured loans. Given the expectations set out in the Draft Guideline, it will also indirectly affect lenders that deal with FRMIs.
The Draft Guideline has been anticipated for some time and follows the release in 2012 of Guideline B-20 - Residential Mortgage Underwriting Practices and Procedures. In many respects, the Draft Guideline is similar to Guideline B-20. The primary difference is that Guideline B-20 applies to institutions that are engaged in residential mortgage underwriting and/or the acquisition of residential mortgage loan assets in Canada and Guideline B-21 will apply to residential mortgage insurers. Another difference is that whereas Guideline B-20, together with certain related legislative changes, was viewed as having a tightening effect on the Canadian housing market, Guideline B-21 is not generally expected to have a significant impact on the housing market.
Comments on the Draft Guideline are to be provided by May 23, 2014.
Principles for sound residential mortgage insurance underwriting
Principle 1: Residential Mortgage Insurance Underwriting Plan
The Draft Guideline provides that FRMIs are to have a comprehensive Residential Mortgage Insurance Underwriting Plan (RMIUP). The RMIUP is to be a document or set of documents that consolidates the FRMI's key mortgage insurance underwriting policies and addresses business objectives, risk appetite and risk management policies as well as other key elements relating to mortgage insurance underwriting.
In connection with the RMIUP, the Draft Guideline addresses: (1) the roles of the Board and Senior Management; (2) the importance of effective internal controls, monitoring and reporting to ensure compliance with the RMIUP; and (3) the requirement that a senior officer make an annual declaration to the Board regarding compliance with the principles in Guideline B-21.
Principle 2: Establishing Standards for the Initial Assessment and Qualification of Mortgage Lenders
Under the Draft Guideline, FRMIs are to establish sound standards for initially assessing and qualifying mortgage lenders for mortgage insurance coverage. The Draft Guideline also provides that lenders should meet applicable qualification standards on an ongoing basis and notes that OSFI expects greater due diligence in respect of lenders that are not prudentially regulated.
Principle 3: Mortgage Insurance Criteria and Insurance Coverage Requirements for Lenders
The Draft Guideline states that FRMIs should establish prudent underwriting criteria that specify the characteristics and parameters of insurable mortgage loans for lenders. The Draft Guideline also states that FRMIs should promote sound mortgage underwriting and loan management practices by mortgage lenders by establishing prudent requirements in their insurance policies. The Draft Guideline sets out specific criteria that OSFI expects will be included in a FRMI's criteria for mortgage loans that it will insure, grouped under the following headings: (i) mortgage loan parameters; (ii) borrower's background and willingness and capacity to service debt; (iii) underlying mortgage property; and (iv) mortgage insurance premiums.
The Draft Guideline states that in order to protect the FRMI's interests and help it control risks, a FRMI should outline (e.g., in insurance policy documents) requirements to be adhered to or carried out by lenders for initial and continuing mortgage insurance coverage. The Draft Guideline sets out minimum elements that should be included in these requirements and states that FRMIs should review these requirements at least annually (or more frequently as needed).
Principle 4: FRMI's Periodic Assessments of Lenders' Underwriting Practices
The Draft Guideline provides that a FRMI should exercise reasonable due diligence regarding lenders' underwriting practices in order to assess consistency with the FRMI's criteria for insuring mortgage loans and compliance with the requirements contained in the FRMI's policy coverage documents. OSFI expects that a FRMI will undertake reasonable inquiries and reviews (which are to be conducted by an independent function) into lenders' underwriting practices. FRMIs are expected to take a risk-based approach to the assessment of an individual lender's practices, including the frequency of those assessments. FRMIs are also expected to establish clear policies for identifying, escalating, and, as needed, addressing weak or non-compliant lender practices.
Principle 5: Assessment and Validation of Underwriting Systems, Models, and Underwriters' Processes
Pursuant to the Draft Guideline, a FRMI should periodically assess and validate its insurance underwriting systems, models, and the processes followed by individual underwriters, to ensure sound insurance underwriting outcomes and consistency with the RMIUP.
The Draft Guideline discusses the use of automated underwriting systems and other models and states that a FRMI should establish an appropriate governance framework for models that outlines the standards and criteria related to the adoption and use of models, data inputs, initial and ongoing validation, and the treatment of model redevelopment and recalibration. For automated underwriting systems, programs should be in place to continuously monitor and audit information received to reduce the potential for inaccuracies and help detect fraud or "gaming".
With respect to underwriters, who typically assess underlying mortgage loans that do not meet standard underwriting characteristics or are otherwise flagged by automated systems, the Draft Guideline sets out OSFI's expectations for applicable processes, including documenting standard operating procedures and underwriting decisions and establishing underwriting authority and escalation processes. The Draft Guideline also addresses the importance of monitoring and evaluating underwriters' practices and the need for internal underwriting audits.
Principle 6: Effective Portfolio Risk Management and other Risk Mitigation
The Draft Guideline addresses the need for effective portfolio risk management practices, including the use of stress testing and reinsurance. OSFI expects that FRMIs will consider appropriate adjustments to mortgage insurance underwriting criteria and premium schedules based on risks identified. The Draft Guideline notes that reinsurance should not be a substitute for sound underwriting and due diligence in respect of lenders and borrowers. The Draft Guideline also addresses the need for FRMIs to exercise heightened prudence for mortgage loan portfolios that constitute greater risks, including greater Board and Senior Management involvement, clear internally-set limits on the insurance of higher-risk mortgage loans consistent with the RMIUP, stronger internal controls and increased oversight of the applicable lenders.
The Draft Guideline provides that a FRMI should publicly disclose sufficient information to enable market participants to evaluate its residential mortgage insurance operations. Public disclosures should include the quarterly publishing of a breakdown of mortgage loans insured during the previous 12 months as well as the total stock of insured mortgage loans. The Draft Guideline provides details regarding how this disclosure should be structured. In addition, the Draft Guideline states that FRMIs should provide a discussion of the potential impact on insured residential mortgage loans in the event of an economic downturn.
Supervision of FRMIs
The Draft Guideline states that a FRMI should maintain and provide to OSFI, upon request, its RMIUP and associated management reports and should promptly inform OSFI if it becomes aware of any mortgage insurance underwriting issues that could materially impact its financial condition.
The Draft Guideline notes that where a FRMI fails to adequately account and control for the risks of insurance underwriting of residential mortgages, OSFI can take, or require the FRMI to take, corrective measures. The Draft Guideline highlights that OSFI's actions can include heightened supervisory activity and/or requiring the FRMI to adjust its capital, commensurate with the risks being undertaken by the FRMI.