In response to increased risks in the mortgage market, Canada’s banking regulator has issued a reminder to lenders about their risk management responsibilities.
The Office of the Superintendent of Financial Institutions (OSFI) this week released a regulatory notice reminding federally regulated lenders of their obligations pertaining to mortgage risk management and underwriting guidelines.
The measures range from being proactive with vulnerable accounts, including “early and proactive engagement with vulnerable borrowers,” to credit loss provisioning and “sound” mortgage underwriting.
“None of the measures outlined in our latest regulatory notice are new,” a spokesperson from OSFI told CMT.
OSFI says the notice is meant to complement its Guideline B-20, while specifically drawing attention to and reinforcing the regulator’s expectations for lenders in the current economic and interest rate environment.
“The notice responds to the heightened risk environment related to existing mortgage accounts and lender portfolios,” OSFI said. “These risks include potential payment shocks and renewal and refinancing risks, particularly for borrowers with higher-risk mortgage products like variable-rate mortgages with fixed payments.”
OSFI confirmed that the notice isn’t in response to a particular lender or their mortgage risk management practices, but instead “reinforces to all lenders the importance of sound mortgage risk management practices through the full lifecycle of the loan.”
As a principles-based regulator, OSFI said it communicates its expectations and tries to avoid being “prescriptive” as much as possible. “…we assess risks to ensure alignment with our expectations and take corrective action when necessary.”
Risks include elevated household debt and high interest rates
OSFI says risks have increased due to a combination of elevated household indebtedness, high interest rates and continued elevated inflation.
As a result, many borrowers are already facing higher mortgage payments, with many more expected to face payment shock upon renewal or in their effort to return to their contracted amortization obligations.
“These risks can lead to more defaults and are particularly acute for borrowers with higher risk mortgage products, such as variable-rate mortgages with fixed payments,” OSFI says.
Canada’s mortgage market is facing a surge in renewals in the coming years, with research from RBC Economics estimating that that $900 billion worth of mortgages—almost 60% of all outstanding mortgages at chartered banks—are due to renew between 2024 and 2026.
Based on current interest rate forecasts over that horizon, a report from CIBC says borrowers will face an average payment shock of about 15% per year.
OSFI has previously communicated its concerns about rising risks in the market in its 2023-24 Annual Risk Outlook that was released last April. At that time, OSFI cited a housing market downturn as one of nine key risks it was monitoring.
“The steep increase in interest rates has eroded debt affordability [and] this is a growing concern from a prudential perspective,” it said.
In response, OSFI unveiled changes to its Capital Adequacy Requirement in December for lenders and insurers with negatively amortizing mortgages with loan-to-values (LTVs) above 65%. Those requirements came into effect early this year.
Concerns surrounding variable-rate mortgages
OSFI’s latest notice reiterates concerns over the risks associated with fixed-payment variable-rate mortgages.
Fixed-payment variable-rate mortgages keep monthly payments stable despite rate increases, leading to higher interest costs and reduced principal repayments. Banks like RBC, TD, BMO, and CIBC offer these mortgages.
Default risks are “particularly acute for borrowers with [these] higher-risk mortgage products,” the regulator said.
OSFI head Peter Routledge has gone as far as referring to them as a “dangerous product.”