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Is CMHC's home valuation system creating risk?

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A Globe and Mail investigation suggests that flaws in a national databank used to assess the value of homes across the country has fuelled higher home prices and could be increasing risk for the country's lenders and borrowers.

According to the media report, a central database known as Emili, which is operated by the government-run Canada Mortgage and Housing Corporation (CMHC) and used by the banks and other lenders to determine the size of a mortgage or line of credit to lend against a property is flawed.

The database is an automated system that determines the value of a home by comparing it against the average price of other properties in the same neighbourhood. The report alleges that industry insiders are concerned over the risks of relying too heavily on an automated system to determine home values, instead of sending an appraiser to the property.

The biggest concern is that using an average price to determine the value of a home – and how much can be lent against it – could overvalue some homes.

"What CMHC did was start to cut corners and they were using averages and as any statistician knows you can hide a lot of sins in the average," Ian Lee at Sprott School of Business at Carleton University, tells BNN. "Averages overvalue the cheaper properties and undervalue the more expensive properties in that zone."

Lee says that the decision to use an average to determine the value of a home is a "shortcut" used to save on the cost of paying for appraisals on individual properties.

"When properties are rising fairly steadily and quickly, it's less of a concern," he says. "Where it becomes a much more pressing concern is on the downward side of the curve…if there are properties declining because there is a gradually winding down of some overvalued properties, then it become much more acute because the lender could be sitting on a house that they thought was worth 350 [thousand], but what is really only worth 300 [thousand], now all the properties ratchet down and the lender wakes up and says 'oh my goodness, we're underwater.'"

He says that this system of determining home values is "potentially serious."

"This method of evaluating houses exacerbates and introduces unnecessary risk into mortgage lending," he says.

Some analysts question the impact of the report's findings on the country's major banks.

"First, the big Canadian banks primarily lend based on an assessment of a borrower’s ability to repay the loan, not the value of the underlying collateral. Second, with average LTVs [loan to value] of 55-60% on uninsured mortgages, appraisal values would have to be significantly different from market values to materially impact this ratio. Third, by law, the CMHC takes the highest LTV mortgages and, as a result, is more exposed to weaknesses in appraisal systems," BMO analyst John Reucassel says in a note to clients.

CMHC says it doesn't simply take an average home value when it assesses a property, but instead looks at a variety of factors.

"CMHC does not use property value averages, but uses the specific characteristics of the property being assessed," a spokesperson tells BNN in an email. "The database and models are continually updated and independently reviewed by a third party. This system is one tool used by CMHC underwriters located across the country to assess the homebuyer’s application for mortgage loan."

The report comes after a recent move by Ottawa to put the CMHC – which is the primary lender of taxpayer-backed mortgages – under the supervision of the financial regulator, the Office of the Superintendent of Financial Institutions (OSFI). The CMHC currently overseas a mortgage portfolio of about $570 billion.

For Lee, Ottawa's decision to put the CMHC under the supervision of OSFI is already paying dividends.

"It was OSFI that caught this problem…it shows how CMHC over the years has watered down the mortgage underwriting rules – the due diligence rules," he says.

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