Canada’s banking regulator says it is considering whether to extend the scope of its mortgage guidelines to include existing mortgages.

In its second Annual Risk Outlook released this week, the Office of the Superintendent of Financial Institutions (OSFI) said it will “consider the scope of Guideline B-20, which currently focuses on mortgage origination, and assess whether expectations should extend to principles for management of existing mortgage accounts and incorporate more recent supervisory insights.”

OSFI’s existing regulatory guidelines apply to all new mortgage originations at federally regulated lenders, including both new purchases and refinances. It’s unknown whether OSFI will apply any future guidelines to switches as well. Currently, its stress test for uninsured mortgages does apply when transferring a mortgage to a new lender.

Asked for further details of what is currently being considered, an OSFI spokesperson told CMT the following: “Since B-20’s inception in 2012, OSFI has clarified its supervisory expectations to lenders on a variety of issues. A number of these issues have touched on risk management of existing mortgage accounts. No decision has yet been taken as to whether or how the scope of B-20 might be revised.”

OSFI has issued new guidelines for existing mortgage products in the past, one example being its June 2020 update that targeted home equity lines of credit and reverse mortgages in excess of 65% of property’s value.

Currently, whenever borrowers pay down any principal, even when it’s above 65% LTV, they can immediately re-borrow that paid-down principal from the line of credit portion.

When those changes come into effect later this year, OSFI said the principal portion of payments over 65% LTV will go towards paying down the overall debt and reducing the total readvanceable mortgage borrowing limit. 

Housing tops OSFI’s 9 market risks

OSFI’s latest risk outlook also listed nine areas of “significant risks facing Canada’s financial system,” with the potential of a housing market downturn being the top risk.

“OSFI is preparing for the possibility, but not predicting that the housing market will experience sustained weakness to throughout 2023,” Superintendent Peter Routledge said on a media call.

OSFI said there is a growing concern about the steep increase in mortgage rates over the past year that has “eroded debt affordability.”

“Mortgage holders may not be able to afford continued increases on monthly payments or might see a significant payment shock at the time of their mortgage renewal, leading to higher default probabilities,” the report notes.

Routledge acknowledged that delinquency rates remain near historical lows, but added the economy has yet to feel the full impact of the rate hikes given that monetary policy typically acts with a lag of 12 to 18 months. It’s been just over a year since the Bank of Canada started hiking its policy rate by 425 basis points.

“In terms of debt-service ratios and delinquencies, they’re quite low by historic standards,” he said. “And so, have we seen any lag effects in a material way in the market? Not yet. And we’re quite gratified that, for the last five or six years, we had in place our mortgage stress test.”

OSFI monitoring variable-rate mortgages

Variable-rate mortgages with fixed monthly payments were singled out specifically, with OSFI saying it is “actively assessing” the risks posed by such mortgages to “determine whether the current capital treatment is fit-for-purpose or revisions are warranted.”

He noted variable-rate mortgages with fixed payments became popular in 2021 and 2022 when rates were at rock bottom, and that many of those borrowers either have or are close to reaching their trigger rate, where their monthly payments no longer cover the interest portion.

“Our concern there is not so much for the immediate term,” Routledge said. “It’s for two to three years out, as those mortgages mature and need to be repriced, they typically will return to the original amortization period. And that would imply a fairly significant increase in monthly payments.”

He said OSFI is asking the institutions it regulates to “define the size of that risk and to develop strategies for lessening the downside of payment shock.” That can include reaching out early to clients and working with them on strategies to adapt to a higher payment, Routledge said.

He added that one factor working to reduce credit risk is that many of those variable-rate products were for five-year terms, and that the borrower will see an increase in wages over that period to help soften the shock of higher payments.

The other key market risks cited by OSFI (in order of importance) include: commercial credit, digital innovation, climate, cyber security and third-party risk.