This Technical Note was prepared by Henry Hoyle (IMF) under guidance of Phakawa Jeasakul (FSAP deputy mission chief). The review was conducted as part of the 2019 Canada FSAP led by Ghiath Shabsigh (FSAP mission chief).
Recent tightening in underwriting standards do not apply for borrowers renewing existing mortgages with their lending institution but do apply to borrowers refinancing at any institution or renewing at other institutions.
This figure includes both stand-alone HELOCs and the HELOC portions of re-advanceable mortgages (see Footnote 3). Stand-alone HELOCs are a smaller share of this segment and contracted in net terms in 2018. See Al-Mqbali, Bilyk, Caputo and Younker, “Re-assessing the Growth of HELOCs in Canada Using New Regulatory Data,” Bank of Canada Staff Analytical Note (2019–14). https://www.bankofcanada.ca/wp-content/uploads/2019/05/san2019-14.pdf
A re-advanceable mortgage typically links a standard residential mortgage with a customized HELOC. Each repayment of mortgage principal is re-borrowed under linked HELOCs, maintaining the borrower’s net indebtedness. One advantage of this structure is that interest on HELOC borrowings used for investment purposes are tax-deductible under Canadian law. https://www.canada.ca/en/financial-consumer-agency/news/2017/06/fcac_report_homeequitylinesofcreditmayputconsumersatrisk.html.
According to data from the mortgage registry Teranet, private, unregulated lenders accounted for 20 percent of mortgage refinancings (defined as mortgage transactions without a home sale) in the Greater Toronto Area in 2018Q2, up from 12 percent in 2016Q2. Half of all private lending is used for these refinancing transactions. https://www.purview.ca/october-2018-teranet-market-insights-report-surge-in-private-lending-in-the-gta/. Investor-led demand was calculated as the share of properties purchased that were immediately relisted for rent. See Bank of Canada Financial System Review June 2018. https://www.bankofcanada.ca/wp-content/uploads/2018/06/fsr-june2018.pdf.
Another factor likely contributing to declining portfolio insurance volumes was the DOF’s introduction of a purpose test in July 2016, prohibiting the use of portfolio insurance as a means of obtaining capital relief.
Earthquake risk is not covered, which is a notable exception. Western provinces are more vulnerable to catastrophic earthquakes, but uptake of property-and-casualty insurance to cover earthquake damages is more common. In the Eastern provinces, where earthquake risk is lower, property-and-casualty insurance coverage is far more limited.
Canadian D-SIFIs’ internal ratings-based insured mortgage risk weight density was under 3 percent as of end-2018. Mortgages insured by CMHC have risk weights of around 0 percent, while privately insured mortgages carry slightly higher risk weights, reflecting the Canadian government’s backstop of 90 percent of private insurance claims.
D-SIFIs include all six D-SIBs and the major provincially regulated credit cooperative in Quebec.
This guarantee ensures that all contractual cash flows are made to securitized instrument holders in full and on time. The sole exception is for pre-payments, which are not protected by the guarantee. The CMHC’s exposure to guarantee losses is limited by the securitization issuers’ responsibility to make payments to bondholders.
An NHA MBS issuer could lose access to the securitization program if it was disqualified due to underwriting problems, or due to adverse market conditions. They may also require liquidity to fund payouts on existing NHA MBS issuance, in instances where securitization asset delinquencies rise but before insurance can cover the claim.
The CMB program removes pre-payment risk on behalf of investors. To do so, it requires that proceeds of pre-paid NHA MBS backing CMBs are re-invested in set of a highly liquid, low credit-risk securities like GoC bonds, repo, and new NHA MBS.
These measures follow several rounds of progressively stricter insured mortgage eligibility rules introduced from 2008–12. These included reducing the maximum amortization period to 25 years; introducing a minimum down payment of 5 percent for owner-occupied properties; and setting the maximum LTV for refinancing at 80 percent. For other policies and further details, see International Monetary Fund, “Canada: Financial Sector Assessment Program: Background Note on Housing,” 2014.
Previously, this stress test applied to borrowers of insured high-ratio mortgages with variable interest rates or fixed interest rates with terms of less than five years. The October 2016 changes expanded the test to all insured mortgage borrowers, including low-ratio mortgages. Gross debt-service and total debt-service ratios (all housing payments and all housing payments plus other debt-servicing payments as a share of total income, respectively) must be 39 percent and 44 percent respectively. The BOC’s posted five-year rate is the mode average of the D-SIBs’ posted 5-year mortgage rates. These are benchmark rates used for qualifying borrowers and calculating mortgage penalties, and in recent years tend to be significantly higher than the actual contracted mortgage interest rates.
In addition to limiting the risks of its exposure to mortgage insurance and securitization via insurance underwriting standards, authorities have also used overall limits on insurance-in-force and securitization.
See International Monetary Fund, “Canada: Financial Sector Stability Assessment”, IMF Country Report No. 14/29, February 2014, p. 15.
Insured mortgage borrowers must pay an upfront insurance premium that varies by LTV ratio. The price impact to the borrower is minimized by the practice of capitalizing these premiums into the principal of the loan, i.e., at the low interest rate and extended amortization of the underlying mortgage. In practice, this is typically equivalent to a small add-on to the borrower’s all-in interest rate, at maximum around 30–40 basis points.
This would apply primarily to banks using an internal ratings-based approach to risk weights, which would include the D-SIBs but not many smaller federally regulated banks. PD figures based on Canadian D-SIBs’ Pillar 3 disclosures as of end-January 2019.
Fernando Ferreira and Joseph Gyourko, “A New Look at the U.S. Foreclosure Crisis: Panel Data Evidence of Prime and Subprime Borrowers from 1997 to 2012,” NBER Working Paper No. 21261, June 2015.
S. Albanesi, G. De Giorgi, and J. Nosal, “Credit Growth and the Financial Crisis: A New Narrative,” NBER Working Paper No. 23740, August 2017.
The BOC’s analysis based on Teranet data suggests that this has happened only to a modest degree so far, as smaller banks and private lenders have slowed lending by less than prime lenders during this period. For details, see Bank of Canada, “Financial System Review,” June 2018, https://www.bankofcanada.ca/wp-content/uploads/2018/06/fsr-june2018.pdf
For details, see International Monetary Fund, “Canada: Financial Sector Assessment Program: Technical Note on Stress Testing and Financial Stability Analysis,” forthcoming 2019.
Bilyk, Olga, Brian Peterson, and Cameron MacDonald, “Interest Rate and Renewal Risk for Mortgages,” BOC Staff Analytical Note 2018–18, June 2018.
The low risk weights for insured mortgages reflect the government backstop for mortgage insurance. Australia’s risk weight floor however overrides the level of risk mitigation offered by private mortgage insurance for prudential reasons.
This policy adjustment need not require an increase in overall capital levels. Risk weight increases could be offset by equivalent reductions in Pillar 2, i.e., D-SIB Domestic Stability Buffer requirements, which are currently set at 1.75 percent of risk-weighted assets. Sweden recently shifted its mortgage risk weight floors from a Pillar 2 (required add-on relative to risk-weighted assets) to a Pillar 1 requirement (incorporated in risk weights).
Authorities currently incorporate a Downturn Loss-Given Default feature to credit risk modeling requirements.
Some of these recommendations may negatively impact homeowner affordability at the margin. Those issues must be weighed against the risk that current policy settings incentivize increased household debt and indirectly contribute to increasing home prices. For recommendations on addressing housing affordability concerns, see the 2018 IMF Article IV staff report.
This policy proposal is developed in Koeppl and MacGee, “Mortgage Insurance as a Macroprudential Tool: Dealing with the Risks of a Housing Market Crash in Canada.” C.D. Howe Commentary No. 430, July 2015.