Rising interest rates are also causing headaches for the regulator of banking institutions. Prudential measures are imposed.
First, let’s review the numbers. The Canada Mortgage and Housing Corporation (CMHC) notes that, since the start of the rate increase in March 2022, a third of mortgage borrowers have seen their monthly payments increase gradually. This is particularly the case for people whose mortgage loan is at an adjustable rate. Additionally, in the first half of 2023, at least 290,000 borrowers renewed their bank mortgages at a higher rate, at 5.45% for five-year fixed rate loans and 7.38%. % for variable rate loans.
The institution estimates that 2.2 million mortgages will face a rate shock in 2024 and 2025, representing 45% of all outstanding mortgages in Canada. We are talking about more than 1 million loans needing to be renewed next year and around 1.2 million in 2025, compared to some 880,000 this year.
Most of these loans were taken out at exceptionally low fixed rates. Holders also most likely borrowed when housing prices reached or were close to record levels, around 2020 and 2021, CMHC assumes. In addition, “the many owners who took advantage of the increase in the equity of their property to refinance their loan will not be spared”.
An order of magnitude ? The federal agency emphasizes that the total amount of mortgage loans that will need to be renewed by 2025 exceeds $675 billion, or the equivalent of approximately 40% of GDP in 2022. Upon renewal, household monthly payments could increase by 30% to 40%. Estimates put the additional interest rates to be absorbed at around $15 billion each year.
According to CMHC’s Mortgage Borrower Survey this year, half of borrowers already directly affected by increased debt service costs say they are having trouble continuing to make certain payments, including mortgage payments. “This figure rises to 74% when we include people who expect to be affected in the coming year. »
Negative damping
It is against this backdrop that the Office of the Superintendent of Financial Institutions (OSFI) saw fit to tighten certain rules in a prudential approach. The organization that regulates federally chartered financial institutions is particularly concerned about the skyrocketing loan-to-value ratios exceeding 100%, pointing in particular to the proliferation of negative amortization that is emerging from variable rate accounts and five-year fixed payments. He agreed to “target variable rate, fixed payment mortgages with a loan-to-value ratio greater than 65% and for which payments are insufficient to cover the interest on the loan for at least three months consecutive, due to increases in interest rates,” we can read on its site.
Without going into detail, institutions will need to hold more equity in negative amortization mortgages. The new requirements also concern mortgage insurers. For loan holders, these changes will not lead to an increase in their monthly payments, he is careful to add.
For these mortgage insurers, CMHC and the two private firms, Canada Guaranty Mortgage Insurance Company and Sagen, the evaluation agency DBRS Morningstar speaks of a non-material impact on their ratio. These insurers are well capitalized, and DBRS believes that the current correction in the residential real estate market is entirely manageable, despite a slowdown in demand and an increased risk of default. This scenario, however, relies on the continued resilience of the labor market.
Using OSFI statistics, DBRS notes that $369 billion in mortgage loans are variable rate with fixed payment. A significant number have an amortization exceeding 35 years. About 20% to 30% of all mortgages are insured.
High rate ETFs
It’s not just mortgage rates that worry you. OSFI is also looking at high-interest exchange-traded funds. Driven by interest rates, “high-interest savings account ETFs, which combine the features of savings accounts with those of exchange-traded funds, have gained popularity among fund management companies, retail investors and deposit-taking institutions. By savings account, we can think of guaranteed investment certificates, whose yield offered has jumped with the explosion in the cost of money.
However, unlike these accounts, which have a long maturity, ETF shares are traded on a stock exchange. They are also not subject to state guarantees or deposit insurance. Specifically, despite having similar characteristics to retail financing, these sources of depository institution financing are provided directly by fund managers for purposes that are not specifically operational, OSFI explains. Thus, in order to hedge liquidity risk, depository institutions exposed to these funding sources will need to hold sufficient high-quality liquid assets, such as government bonds, to cover all interest account ETF balances. high which can be withdrawn in less than 30 days.