Canada’s banking regulator recently confirmed it will move ahead with new capital requirements for lenders and insurers with negatively amortizing mortgage portfolios.

Starting in early 2024, the Office of the Superintendent of Financial Institutions (OSFI) will require lenders to hold more capital for negative amortization mortgage balances with loan-to-values (LTVs) above 65%.

• What’s a negative amortization mortgage? Negative amortization can impact borrowers with fixed payment variable-rate mortgages in an environment when prime rate rises significantly, resulting in the borrower’s monthly payments not covering the full interest amount. This causes the mortgage to grow rather than shrink.

“We have updated several of our capital guidelines to promote prudent allocation of capital against risks that lenders and insurers take,” OSFI superintendent Peter Routledge said in a statement.

The changes were first announced by OSFI in July and were subject to a consultation period over the summer. They will primarily impact three of Canada’s big banks that currently offer fixed-payment variable rate mortgages and allow negative amortization mortgages: BMO, CIBC and TD.

For these banks, variable-rate mortgages comprise about a third of their overall portfolios (32%-39%), with roughly a quarter of those mortgages with extended amortizations beyond 30 years.

While RBC does offer fixed payment variable rate mortgages, it does not allow its mortgages to amortize negatively.

Scotiabank and National Bank of Canada, meanwhile, offer adjustable-rate mortgages where the borrower’s monthly payment fluctuates as prime rate changes. As a result, both banks have less than 1% of their variable-rate portfolios with amortizations above 30 years.

The new requirements will also impact Canada’s three mortgage insurers, which insure between 20% and 30% of all mortgages. Also effective in January, the maximum LTV ratio for individual mortgages in the Mortgage Insurer Capital Adequacy Test (MICAT) capital formula will increase from 100% to 105%. This adjustment aligns the MICAT capital formula with the maximum permitted LTV ratio for insured mortgages.

The new guidelines also set a limit of 40 years on the mortgage’s remaining amortization length for the purpose of calculating regulatory capital.

“Given the relatively low prevalence of negative equity mortgages, the overall impact for mortgage insurers is expected to be minimal, resulting in an immaterial decline in the capital ratio,” DBRS Morningstar noted in a report.

“Our expectation is that underwriting profitability will weaken somewhat but be manageable from a credit quality perspective given mortgage insurers’ strong capital buffers and conservative credit underwriting criteria,” the report added.

Impact on banks to be manageable, Fitch says

In its own report, Fitch said the Capital Adequacy Requirements (CAR) for the banks are likely to be “comfortably absorbed.”

The ratings agency said the changes should impact common equity tier 1 (CET1) ratios by only 7 to 22 basis points, “or less than 2% of the average 3Q23 13.5% CET1 capital for the four banks with exposure,” it said. “As of 3Q23, all banks had CET1 ratios comfortably above regulatory minimums.”

OSFI’s reasoning for cracking down on fixed payment variable-rate mortgages

OSFI has repeatedly voiced its concerns about fixed payment variable-rate mortgages, first singling them out in its Annual Risk Outlook for 2023-2024.

Most recently, during testimony before the Standing Senate Committee on Banking, Commerce and the Economy earlier this month, Routledge said increasing mortgage balances associated with negative amortization “increases their vulnerability, and increases the risk of default.”

“The variable rate product with fixed payments is a dangerous product in our view because it puts the homeowner in the position of an extended extended period—not always, but in this environment certainly—it can put the homeowner in the position of paying a flat rate of, say, $2,000 a month, and the interest on their mortgage is $3,000 a month,” Routledge said.

And while Routledge said OSFI’s role is not to “impose a judgment on product design,” he did say OSFI would “like less of that product.”

In response to stakeholder feedback on these new capital requirements that the implementation timeframe is “very tight,” OSFI responded by saying it was important to “address the risk in a timely manner.” As such, the new capital requirements will take effect in fiscal Q1.

Correction: This article has been updated to acknowledge the fact RBC does not allow negative amortization mortgages, and will therefore not be materially impacted by OSFI’s new capital requirements.

big banks capital adequacy requirement CAR fixed payment variable rates MICAT mortgage insurers Office of the Superintendent of Financial Institutions OSFI OSFI regulations regulations variable rate mortgages

Last modified: January 11, 2025