The mortgage stress test has helped protect Canada’s housing market in this downturn: OSFI


The mortgage stress test has thus far proven effective in protecting the housing sector from a volatile economy, but further changes haven’t been ruled out, says Canada’s banking regulator.

The comment was made on Thursday by Peter Routledge, head of the Office of the Superintendent of Financial Institutions (OSFI), which in December maintained its qualifying rate for uninsured mortgages. As part of the mortgage stress test, borrowers must prove they can afford payments at the higher of 5.25% or two percentage points above their contract rate.

“We just absorbed a 1980s-level increase in interest rates, and mortgage delinquencies remain at historic lows,” Routledge told a small group of reporters backstage in Toronto following an event sponsored by the Economic Club of Canada. “We’ve been through this for a year, and you would expect to have seen some speck of deterioration, but it really hasn’t.”

While OSFI is considering potential further changes to Guideline B-20, which governs mortgage underwriting practices and procedures, Routledge says the fact that mortgage delinquencies remain at an all-time low of 0.15% in the face of rising interest rates, inflation, and economic uncertainty proves the policy is working as it was intended. At the same time, those economic forces, coupled with the elevated share of mortgage borrowers with variable-rate mortgages, has caused the agency to consider further changes.

Are changes to the stress test coming?

On January 12, OSFI announced several proposed changes it said it would consider following a consultation period with industry stakeholders. That consultation period wrapped up on April 14.

“The level of household indebtedness in Canada is a vulnerability we take very seriously, and it is an area we have been and will continue to monitor carefully,” Routledge said in his prepared remarks. “That longstanding vulnerability is made riskier today by elevated mortgage interest rates, and a potential economic downturn.”

In fact, OSFI called out the housing market as one of the most significant economic risks in its recently released Annual Risk Outlook for 2023.

Routledge says the agency received significant feedback from its public consultation on its potential changes, but wouldn’t share whether the input was pushing OSFI in one direction or another. “We’ll have some decisions to make in terms of whether to do anything different,” he said.

If changes are to be made, however, Routledge says variable rate mortgages would likely be the primary target.

Variable rate mortgages remain a risk

At the height of the pandemic’s housing boom when interest rates were at rock-bottom, roughly half of new mortgage originations and a third of total outstanding loans were variable-rate products. This, according to Routledge, represents a potential risk to both Canadian households and the broader economy over the longer-term, especially if borrowing costs remain elevated.

“What we’re interested in understanding is if folks have ideas about how we might think about that,” said Routledge during an onstage Q&A with Doug Turnbull, the Vice Chairman and Canadian Head of DBRS Morningstar. “Is it okay? Or should there be additional or alternative or other measures in B-20 that might attenuate that sudden buildup of variable rate mortgages, which comes with a fairly substantial degree of risk for households?”

Routledge adds that the risk is heightened for variable-rate holders with fixed payment terms, and especially those who now find themselves in a negative amortization situation.

“Over the course of time, as the product matures and they have the opportunity to renew their mortgage, borrowers and financial institutions will have to work through whatever that payment shock is in a way that ensures Canadians stay in their homes,” he says. “The history of Canadian mortgage underwriting shows that our players… know how to work towards that common goal.”

Routledge says that housing and mortgages are always top of mind for Canadian financial regulators. But in a speech that was largely dedicated to the fallout from a series of recent bank failures, the threat of climate change on Canada’s economic future, and the long-term health of Canada’s financial system, concerns about the mortgage market seemed relatively tame.

“We want to make sure our B-20 Guideline adds a margin of safety to our buildup of those types of mortgages, but does that buildup cause me any sleepless nights? No,” Routledge said.

Furthermore, Routledge acknowledges that borrowers have shown strong demand for variable rate mortgages, lenders have demonstrated an interest in offering them, and delinquencies haven’t budged through this recent period of economic instability. As a result, the industry shouldn’t necessarily expect substantive changes to B-20 anytime soon.

“There’s been this perception that OSFI is tightening underwriting standards, but we certainly never intended to communicate that,” he said. “We haven’t had any bias in terms of tightening or loosening mortgage underwriting; we just simply want to see what the experience tells our constituents about the mortgage system, and how we can make it safer.”

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