Alternative lenders in Canada have doubled their share of the residential mortgage market in the past decade, increasing risks in the housing sector where they operate with limited federal government oversight.
These mortgage providers, which fall outside the responsibility of Canada's main banking regulator, increased their share of the $1.4-trillion mortgage market to about 13 per cent last year from 6.7 per cent in 2007, according to the finance department. The lenders, also known as the shadow or private market, cater to the self-employed, new immigrants and those turned down by regular banks. They include publicly listed companies, investor groups and retirees who borrow against their homes to provide funding.
"It really is Joe Schmo taking business from the banks," said Nicholas L'Ecuyer, 36, who works out of a converted church in Barrie, Ont., a 90-minute drive north of Toronto's financial centre. As one of the top 10 mortgage brokers in Canada by volume, he helped arrange about 430 mortgages worth $120-million last year. Roughly a third of that was from lenders that weren't regulated by the Office of the Superintendent of Financial Institutions, he said.
"Banks used to have looser ways to check for mortgage lending, and as that started to tighten, it pushed people to the B space. And as they tightened up, it squeezed even more into the private market," L'Ecuyer said.
Lightly regulated lenders are expanding following changes in recent years that reduced amortization periods and put greater emphasis on employment verification, making it harder for self-employed borrowers or those with weak credit scores to get a loan from commercial banks. New lenders are also tempted by high returns from mortgages with interest rates as high as 20 per cent, at a time when 10-year government bonds yield just 1.2 per cent.
The lenders are overseen by provincial bodies such as the Financial Services Commission of Ontario, which have the ability to revoke licenses and collect some data via annual surveys. These agencies don't shape policies or track leading indicators of risk, such as the total amount of mortgage loans outstanding from the private segment, average credit scores of the loans, and defaults.
The expansion by shadow lenders comes as the Bank of Canada warns that strains such as record consumer debt tied to the housing boom pose the single biggest risk to the country's financial system. The central bank was looking to expand its "market intelligence" team in part to monitor the less-regulated lenders as capital rules tighten on traditional banks, Deputy Governor Lynn Patterson said in May.
"Prudentially unregulated mortgage lenders represent a relatively small portion of the mortgage market," Paul Duchesne, a spokesman for the finance department, said in an e-mail. Most of the lenders also insure their mortgages through the national housing agency, Canada Mortgage & Housing Corp., or securitize their mortgages, and so must comply with federal rules, he said.
The industry may be small but it's booming, along with housing markets in cities including Toronto. Mortgage brokerages arranged C$148-billion worth of loans from both banks and alternative sources in Ontario in 2014, up 45 per cent from the prior year and almost double the 2010 level, according to the most recent data from the financial services commission. Online ads from shadow lenders flood Kijiji.ca and social media, blaring mortgage solutions for "bad credit," "self-employed," "can't prove income," often on "quick approval."
Financial filings reveal just how quickly alternative market growth is outpacing traditional lenders such as the Royal Bank of Canada. First National Financial Corp., the largest of its peers in Canada, had $93.8-billion in mortgages under administration at the end of last year, a 76 per cent jump from five years ago. Street Capital Group Inc.'s mortgages outstanding jumped five-fold to $24.8-billion in the same period. The mortgage book at MCAP Corp. is set to double to at least $90-billion by 2020.
"In any market there's risk, and it depends on how you're pricing for that risk," Edward Gettings, chief executive officer of Street Capital said by phone. The Toronto-based lender is in the process of obtaining a bank licence, which would place it under OSFI's regulation, he said. "We already act as if we are regulated, and once we get that license we will be regulated."
First National wasn't available to comment and MCAP declined to comment.
Meanwhile, brokers can't keep up with demand. L'Ecuyer stopped to chat with his neighbour last week en route to work. By the end of the conversation, he'd gained another client. The prospective investor is a business owner who recently downsized to a smaller home and has about $300,000 to invest.
"He was asking about typical returns, yields on investment – and when he heard they were double digits, he said 'I'm in,'" L'Ecuyer said.
The next step is filling out a form outlining lending parameters and risk-appetite, then the broker connects the investor's money with a borrower. Brokers charge a fee ranging from 1 per cent to 10 per cent.
L'Ecuyer's neighbour typifies the new crop of mortgage lenders in Canada: retired or close to it, with least $200,000 saved up or taken out of their own property via a home equity line of credit. They operate on their own or as part of a MIC, or mortgage investment corporation, which pools funds to invest in mortgage portfolios. The number of MICs jumped 81 per cent to 188 groups funding $2.3-billion in Ontario alone in 2014 from the prior year, according to FSCO.
One of these MICs, PrimeWest Mortgage Investment Corp., suspended its dividend and boosted its loan-loss provisions after a review of its portfolio revealed a lack of adequate security and failure to follow lending policies, according to a statement Tuesday from the Saskatoon, Sask.-based company.
"The banks really don't have any tolerance for work, or for risk," said Matthew Robinson, CEO at Sharbot Lake, Ont.-based Pillar Financial Services Inc. and Frontenac Mortgage Investment Corp. Pillar is set to have its busiest year, Robinson said. More than half the mortgages in the Frontenac fund, which sources its mortgages from Pillar, have interest rates above 9.5 per cent.
Some lenders and even brokers are concerned with the level of activity. Home Capital Group Inc. CEO Martin Reid said that the stricter mortgage regulations caused unintended consequences that need to be monitored. The lender is regulated by OSFI and competes with banks and alternative lenders.
Introducing new regulations "may not have been the most prudent thing to do," he said at a conference this month. "It's increasing risk into an area where you don't have line of sight."
The risk doesn't faze L'Ecuyer in Barrie, who regularly turns down lenders and borrowers when the finances don't make sense. "Yes, it's more risky but it's up to the broker to choose a lender and protect the buyer," he said. "It also only becomes a problem if home prices drop, and that's not an issue right now."