“Everyone is getting nervous now,” says Phil West, a veteran of the appraisal industry who is critical of Emili. “There is more and more potential of a downturn in the marketplace. And everyone is looking at: Where is the Achilles heel?”
Although the issue has been kept out of the public eye, documents obtained by The Globe and Mail show that concern about inaccuracy, flawed data, and risk within the system has spread to the highest echelons in Ottawa and in the banking industry. In the spring, the federal banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), acted on alerts from industry insiders and ordered banks to stop relying so heavily on automated systems when approving mortgages.
The time had come, OSFI warned, for Canadian lenders to be more rigorous.
Until the mid-1990s, borrowing money to buy a home was, by today’s standards, a more tedious exercise. The bank looked at a proposed transaction to determine if the buyer could afford the payments, and typically sent an appraiser to see if the home represented sufficient collateral for the loan.
The appraiser inspected and measured the house, and took rolls of photos that were dropped off for developing. Back at the office, the appraiser sifted through books of recent sales data on similar homes in the area. The whole process took two or three days. The cost, about $200, was typically passed on to the consumer.
Because they cost time and money, such on-site appraisals were not popular with consumers and real estate agents hurrying to close a sale. “It’s when the appraiser gets involved that there’s a problem,” Rick Sieb, a long-time appraiser in the Vancouver area, says sardonically. “We’re just a big pain in the ass.”
The approach to appraisals changed dramatically in 1996, when CMHC introduced its Emili system.
CMHC encourages banks to lend by insuring mortgages where the buyer has a down payment of less than 20 per cent. It charges the borrower a premium for the service, and essentially allows the banks to offload the risk of a default onto the government.
In the mid-1990s, CMHC created Emili as a computerized tool to determine quickly if a loan was safe from risk of default, based on the estimated value of the home and several other factors. Information about the house, the buyer, and average sales for the area were fed into the program, which then spit out a risk assessment. Internal lore has it that Emili was named for the daughter of a former CMHC vice-president.
The system was only used internally at first. But in 1996, Emili was offered to banks, for a fee, allowing them to also use the software on uninsured mortgages and refinancings where CMHC wasn’t involved.
Touted as a ground-breaking “loan decisioning system” by CMHC, Emili would compress application approval times for the banks “from days to seconds.” And since using Emili was faster and cheaper than sending out an appraiser to look at the house, CMHC said the system would “increase profits” for banks.
Not surprisingly, the lenders were anxious to buy in. “The banks asked us to use it,” Pierre Serré, the chief risk officer at CMHC, said in an interview.
The invention was a hit. Though Emili isn’t the only system of its kind – other mortgage insurers and data companies have their own computerized models – it is by far the one in widest use, stamping its approval on hundreds of thousands of Canadian mortgages each year.
Though CMHC is reluctant to detail exactly how the Emili system works, it’s very simple from the banks’ perspective. For a fee of about $50, “you ping CMHC to say I have this house on this street at this address,” said David McKay, head of retail lending for Royal Bank of Canada, the country’s largest bank. “You ask, is it worth $300,000? You send them a question, and they come back saying it’s in the range – yes or no. They don’t feed you a number back, they tell you it’s in the range, or it’s outside. And then you have to say, ‘Okay, good enough for me. I’m going to lend against $300,000.’ ”