The credit risk for residential real estate has increased “only modestly,” says OSFI

The head of the agency charged with overseeing Canadian government-regulated lenders said Tuesday that residential mortgage credit risk had increased “only modestly”.

Peter Routledge, Head of the Office of the Superintendent of Financial Institutions (OSFI), gave a virtual speech to financial analysts in Vancouver.

This is against the background of “very significant” increases in home prices, which rose by 23% in October compared to the previous year (seasonally adjusted) to an average price of USD 716,585. Home prices have increased by over 30% in some markets. At the same time, the supply of apartments has fallen to a record low, with only 1.9 months of inventory available, compared to a long-term average of around five months.

Overall, residential mortgage loan growth is growing at around 10% annually.

“Although the word ‘exuberant’ has characterized housing markets in many Canadian cities since the fall of 2020, we at OSFI believe that the credit risk on residential mortgages has increased only marginally,” Routledge said in his prepared remarks. “Despite this exuberance and rising mortgage credit, Canadians are spending less income on debt servicing payments such as mortgage payments, car loans and credit card payments.”

Routledge added that OSFI had used several “regulatory tools to increase the margin of safety” in the residential mortgage loan market. This includes stress tests of borrowers at a higher interest rate (currently 5.25%) as well as an additional review of the property valuation and the setting of “dynamic” lending limits that better reflect the risk of certain properties and markets.

“Still, we view the current mismatch between housing demand and supply as a significant regulatory risk and all actors in Canada’s housing system must take steps to reduce the risk,” he said. “The greatest regulatory risk in the Canadian financial system is the mismatch between supply and demand in housing.”

He noted that intergovernmental efforts were needed to address the housing mismatch in Canada.

On the role of rate product selection in overall risk assessment, Routledge found that floating rate mortgages are “more popular than ever,” accounting for over half (51%) of all new home mortgages in recent months.

“Because variable mortgage rates are lower than fixed mortgage rates, new homebuyers may accept the increased interest rate risk associated with variable mortgages in order to become homeowners,” he said.

Expandable HELOCs under the microscope from OSFI

Routledge added that non-traditional home-secured loan products, such as Combined Mortgage-HELOC Loan Plans (“CLPs”), could also lead to spikes in property valuations, as they often include an easily transferable loan component that increases with principal payments made.

“CLPs are a focus area for OSFI because they represent a significant portion of Canada’s uninsured mortgage debt,” he said. “The use of HELOCs and non-traditional property-backed products can result in larger and more permanent outstanding capital balances and increase the risk of loss for lenders.”

He added that these products can make it difficult for lenders and regulators to quickly assess credit risk during times of stress.

“If OSFI sees rapid growth in products, it is our job to understand why and what risks the growth may pose to institutions and the economy,” he said. “In addition, there is the possibility that such products will not meet our actuarial expectations as the product structures continue to develop. We asked the lenders to carefully examine the risks associated with their own combined loans and HELOC mortgage structures. “

BoC describes high household debt as worrying

In a separate speech on Tuesday, Bank of Canada Deputy Governor Paul Beaudry said the rising prevalence of highly indebted households was a growing concern for the bank.

“… the upward trend we saw for two decades in the proportion of households that are considered highly indebted – that is, with a debt burden in excess of three and a half times their income – stalled,” he said in prepared notes for the Ontario Securities Conference Commission. In 2019, almost every sixth household with debt was considered highly indebted.

“Our analysis found that the overall prevalence of heavily indebted households likely improved in the first year of the pandemic,” Beaudry said. “But we’ve also found that the deteriorating quality of new mortgage credit over the past few quarters is now likely to be the major contributor to household debt. By the end of 2021, the proportion of heavily indebted households will likely have more than reversed its initial improvement and passed its 2019 high. “

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