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Housing market risk has risen only modestly, OSFI says

Residential Mortgage Credit Risk Has Risen “Only Modestly,” Says OSFI

The head of the agency charged with overseeing Canada’s federally regulated lenders said Tuesday that residential mortgage credit risk has risen “only modestly.”

Peter Routledge, head of the Office of the Superintendent of Financial Institutions (OSFI), made the comment during a virtual speech to financial analysts in Vancouver.

That’s against the backdrop of “very significant” home price increases, which are up 23% as of October compared to a year ago (on a seasonally adjusted basis) to an average price of $716,585. In some markets, home prices are up over 30%. At the same time, housing supply has plummeted to record low levels, with just 1.9 months of inventory available, down from a long-term average of about five months.

Overall, residential mortgage credit growth is rising at a pace of about 10% annually.

“Although the word ‘exuberant’ characterizes the housing markets in many Canadian cities and towns since the fall of 2020, we at OSFI believe residential mortgage credit risk has risen only modestly,” Routledge said in his prepared remarks. “Despite this exuberance and rising mortgage credit levels, Canadians are dedicating less income to debt service payments such as mortgage payments, automobile loans and credit card payments.”

Routledge added that OSFI has leveraged several “prudential tools to increase the margin of safety” in the residential mortgage credit market. This includes stress-testing borrowers at a higher interest rate (currently 5.25%), along with added scrutiny on property valuations and establishing “dynamic” loan-to-value limits that better reflect the risk of specific properties and markets.

“Nevertheless, we consider the current imbalance between housing demand and supply to be a material prudential risk, and all actors in the Canadian housing system must take actions if we are to lessen the risk,” he said. “The greatest prudential risk in Canada’s financial system is the supply/demand imbalance in housing.”

He noted that intergovernmental efforts are required to address the housing demand and supply “mismatch” in Canada.

Commenting on the role of rate product selection in the overall risk assessment, Routledge noted that variable-rate mortgages are “more popular than ever” and now account for over half (51%) of all new residential mortgages in recent months.

“As variable mortgage rates are lower than fixed mortgage rates, new homebuyers may be accepting the elevated interest rate risk that comes with variable-rate mortgages in order to become homeowners,” he said.

Readvanceable HELOCs Under OSFI’s Microscope

Routledge added that non-traditional housing-backed lending products, such as Combined Mortgage-HELOC Loan Plans (“CLPs”), could also be fueling an increase in home valuations, as they often include a readvanceable credit component that increases as principal payments are made.

“CLPs are an area of focus for OSFI as they represent a significant portion of uninsured Canadian household mortgage debt,” he said. “The use of HELOCs and non-traditional housing backed products can lead to greater and more persistent outstanding principal balances, increasing risk of loss to lenders.”

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

“When OSFI sees products growing rapidly, it is our job to understand why and assess what risks that growth may present to institutions and the economy,” he said. “Further, as product structures evolve, there is a potential that such products become non-compliant with our underwriting expectations. We have asked lenders to closely review the risks arising from their own combined loans and HELOC-mortgage structures.”

BoC Says High Household Debt a Concern

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

“…the upward trend that we saw for two decades in the share of households considered highly indebted—that is, with a debt load that exceeds three and a half times their income—came to a halt,” he said in prepared remarks to an Ontario Securities Commission conference. In 2019, close to one in six households with any debt were considered highly indebted.

“From our analysis, we found that the overall prevalence of highly indebted households likely improved during the first year of the pandemic,” Beaudry said. “But we also found that the deteriorating quality of new mortgage borrowing during recent quarters is now likely the bigger driver of household indebtedness. By the end of 2021, the share of highly indebted households will likely have more than reversed its initial improvement and topped its 2019 peak.”