Ottawa's attempt to cool Canada's overheating housing market and impose stricter regulations on mortgage lending is likely to have a profound impact on alternative lenders that compete with the country's largest banks.
The new rules, announced Monday, apply to all residential mortgage lenders. However, the banks, which account for 70 per cent of the market, have the highest underwriting standards in the country – and the implicit message has been that Ottawa is most worried about the alternative lenders.
The stock market showed its concern with the growth prospects of alternative lenders on Tuesday, when share prices for Home Capital Group Inc. and First National Financial Corp. fell 3 per cent and 8 per cent, respectively. The fear is that the regulatory changes will create an unlevel playing field in the banks' favour, by reducing options for some home-buying consumers.
"These are major, major changes," said Rob McLister, founder of RateSpy.com, a website that compares available mortgage rates. "The Department of Finance has handed the banks a gift-wrapped opportunity to get more business on their own, because they are going to be the only game in town in many cases."
To compete, many alternative lenders target less desirable borrowers – those with lower credit scores and those who put the minimum amount down on large mortgages. Ottawa's new rules require all borrowers to qualify for mortgages assuming much higher interest rates, which has the potential to shut higher-risk borrowers out of the market.
"The sense I get is that this is going to slow housing activity. This is going to slow mortgage lending," said Sherry Cooper, chief economist at Dominion Lending Centres.
"To that extent, it's bad news," Ms. Cooper says. "But it's not bad news if they prevent a housing bubble and collapse."
The government and regulators have been keeping a close eye on unregulated mortgage lenders. An internal memo from the Department of Finance, released to The Globe and Mail under the Access to Information Act in August, noted that these lenders have seen their market increase to 15 per cent of mortgage originations.
One reason given for the growth: As new regulations raised the qualification thresholds for insured mortgages from banks, consumers looked elsewhere for financing.
This summer, Canada's banking watchdog, the Office of the Superintendent of Financial Institutions, called for an increased effort on the part of mortgage providers to verify borrowers' income levels – a move widely seen as a reaction to alternative lenders.
Home Capital Group Inc. suspended nearly four dozen brokers last year on allegations their files contained falsified income documents.
Although it is easy to wrap all alternative lenders under the same banner, there is some differentiation between them. For example, some target so-called Alt-A mortgages, which are considered a type of subprime loan, more than others.
But First National says it has always applied the same standards that OSFI requests of the big banks, and its average mortgage size is about $300,000, which means it isn't terribly exposed to large loans.
In an e-mail, First National chief financial officer Rob Inglis noted the company is still working through the new rules to determine their impact on its business. But he added that the lender "always held itself to a high standard of underwriting. We do not expect this to change."
Recently, the company suggested such standards could help it stand out from rival alternatives as the government cracks down. Mr. Inglis alluded to this in his e-mail: "We will endeavour to maintain this competitive advantage as the marketplace evolves."
This round of rule changes will bring a different response than previous changes, which have tended to push consumers toward alternative lenders.
"Every time we tighten the mortgage rules, we know that the market share held by unregulated lenders will increase," said James Laird, president of CanWise Financial, a mortgage brokerage owned and operated by RateHub Inc.
This time, though, tighter regulations will likely lower the number of transactions. "Any tightening will push a few people out of the market," Mr. Laird said, adding that a first-time home buyer with a down payment of less than 20 per cent will be able afford 20 to 25 per cent less.
The uncertainty for alternative lenders also has the potential to spell trouble for MCAP Corp., whose residential mortgage portfolio totalled $48-billion at the end of 2015. The company tried to go public in a $275-million initial public offering in May, and the deal was launched to great fanfare, but ran into trouble when Britain voted to leave the European Union in June. A week later, MCAP pulled the deal, citing market volatility.
The IPO has been on hold since, and investors' current skittishness over alternative lenders doesn't give much reason to bring it back soon. It is also unclear if company's growth projections will need to be updated following the new rules. In May, MCAP projected growing its total mortgage portfolio, which includes some commercial loans, by 70 per cent by 2020. The company did not return a request for comment.