OSFI keeps watch on mortgage lenders as rates rise, home prices cool

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Borrowers with adjustable-rate mortgages about to be renewed are particularly at risk

Homes for sale in East Gwillimbury, Ont. Homes for sale in East Gwillimbury, Ont. Photo by Cole Burston/Bloomberg Files

Canada’s banking regulator is sounding the alarm about rising mortgage market risks amid rising interest rates and falling home prices. While the Office of the Superintendent of Financial Institutions didn’t announce any new measures when updating its fact sheet on residential mortgage underwriting this week, it did stress the need to be ready to face these emerging risks.

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“[Federally regulated financial institutions]need to ensure they are prepared to deal with the potential impact of lower home prices and higher interest rates,” the report said. “In particular, the amount of loss that lenders suffer depends not only on the probability of default, but also on how much of the loan the banks would lose in the event of default.”

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As another potential risk, OSFI pointed to the high debt of Canadian households, which accounted for 182 percent of disposable income in the second quarter of this year. The regulator found that a combination of this record debt, persistently high inflation, which hit 6.9 percent in September, and further rate hikes by the Bank of Canada would weigh on Canadians’ ability to make mortgage payments.

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Using more of their income to pay off mortgages could reduce savings or cause Canadians to scale back spending in other areas of the economy, OSFI found. For aspiring homeowners, the combination means looking for cheaper housing options, increasing down payments, or delaying the purchase.

Borrowers with adjustable-rate mortgages that are about to renew are particularly at risk, according to OSFI, as they will feel the impact of rate hikes sooner.

The regulator also defended the mortgage stress test, arguing that ensuring buyers could still afford the higher contract rate plus 2 percent and 5.25 percent provided a safety margin to prevent some borrowers from financially overextending themselves.

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Jaeme Gloyn, an analyst at the National Bank, and Julia Gul, a staff member, said the new comment reinforced the bank’s cautious stance on the residential mortgage sector.

“Mortgagors are becoming increasingly leveraged and rising interest rates are only increasing the debt-servicing burden on those borrowers,” Gloyn and Gul wrote in an Oct. 18 note. “Combined with eroding homeowner equity as home prices soar, this environment could result in higher-than-expected losses for OSFI-regulated lenders.”

The National Bank added it does not expect the regulator to relax its underwriting standards any time soon. Analysts also pointed to rising political uncertainty, an aggressive streak of rate hikes and housing market risk as upcoming challenges for the sector.

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“We have been able to see the impact of ‘payment shocks’ on renewing borrowers’ flow-through loan performance, given that borrowers are struggling to service a higher mortgage payment,” the note said. “For borrowers who received their mortgages in Q3 2021, we estimate a $1,000 increase in monthly mortgage payments. These higher mortgage payments, along with other inflationary pressures (e.g. food, fuel) could weigh on borrowers’ ability to pay.”

Gloyn and Gul estimate that Home Capital Group Inc. borrowers could face a $1,190 increase in their monthly payments over the next year as 66 percent of those mortgageholders need to roll over. While Equitable Group Inc. does not provide the disclosures necessary to conduct a similar analysis, the bank said it was safe to assume similar results for EQ Bank.

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National Bank gave EQ Bank an outperform rating with a $73 price target and sector performance on Home Capital with a $31 price target. Shares in EQ Bank were at $45.83 on Wednesday afternoon and shares in Home Capital were trading at $27.57.

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Earlier this week, OSFI’s superintendent of financial institutions, Peter Routledge, said the regulator is constantly looking at the risk horizon and determining whether it has the necessary buffers to weather potential financial storms.

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“We’ve never had such thick buffers to protect our financial system from adverse events,” Routledge said during a panel discussion at the Toronto Center on Oct. 17 in Toronto. “Is that enough? It’s necessary, but it’s not entirely sufficient. What makes it entirely sufficient is a regulator that has the will to act.”

Routledge said regulatory will to act had been needed since OSFI’s inception in the wake of the 1987 global financial crisis, once potential troubles were identified on the horizon.

“That’s my obsession now … as we enter tougher times with higher debt servicing costs resulting from higher inflation,” Routledge said.

“If we are willing to take that risk (acting early) we will add what is necessary and sufficient to the resilience of the system and I think we will handle whatever comes our way quite well as we have in the past have done .”

• Email: [email protected] | Twitter: StephHughes95

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