A Quiet Announcement That Could Have a Big Impact on Future Canadian Mortgage Rates
Monday Morning Interest Rate Update for September 19, 2016
When OSFI makes changes, it first issues a proposal that is “open for public consultation” up to a certain deadline, which in this case is October 18. But OSFI is making this proposal in the same way that I propose to my kids that they brush their teeth before bed – while technically I am asking, one way or another, it’s going to happen.
In its recently revised Capital Adequacy Requirement (CAR) Guideline, which is designed “to ensure that capital requirements continue to reflect underlying risks and developments in the financial industry”, OSFI has made allowances for increased risk at both the individual and market levels.
To account for increased market risk in future, OSFI will add a “countercyclical buffer” to its toolkit. This buffer will require lenders to put aside more capital if OSFI perceives that market risks have become unduly elevated. So, for example, if house prices continue to accelerate in hot regional markets, OSFI could increase lender capital requirements, thereby increasing the cost of the funds that are being lent out.
Bluntly put, this buffer gives our policy makers a clever way to increase mortgage rates while leaving other interest rates unchanged, something that they see as desirable. And while it’s true that lenders will be given a grace period of six to twelve months to raise the required capital, you can bet that they will move rates higher immediately after being notified that a countercyclical buffer will be implemented.
At the individual lender level, OSFI also reminded lenders that “credit risk insurance is a risk mitigant (guarantee) that relies on the due diligence of a mortgage originator”. To that end, if OSFI perceives that lenders have not met the agreed upon standards when underwriting insured loans, it will require them to put up more capital to account for their lack of adequate due diligence.
OSFI is effectively warning lenders that they should apply the same credit standards to loans that are backed by Canadian tax payers as they do when lending their own money. This emphasis is an attempt to address “moral hazard” risks whereby lenders loosen their standards on loans where default insurance protects them against potential loss.
There have been far more radical proposals to address moral-hazard risks of late. One idea making the rounds is the introduction of a first-loss deductible that would require lenders to participate in any losses incurred on their insured loans. While this would certainly give lenders pause before applying looser standards to insured loans, it would be difficult to superimpose this type of change on our existing default-insurance framework. For example, CIBC Deputy Chief Economist Benjamin Tal recently speculated that introducing risk sharing could both push rates higher and limit the availability of mortgage credit. As such, each of these changes would be destabilizing.
Canadians have grown accustomed to reading headlines about housing-bubbles with their morning coffee but these warnings have grown increasingly ominous of late, even by our own jaded standards. Our still relatively new federal government is facing increased pressure to do something, and thus far, their handling of the housing file remains an open question.
Will they be satisfied with allowing OSFI to continue with its existing oversight and to add to its toolkit as needed, while allowing regional markets to implement area-specific policies to address local imbalances such as the new Vancouver real-estate tax on foreign investment? Or will they implement more radical reforms that might play better at the ballot box but come with a greater risk of unintended consequences? Time will tell (and I will be watching for you).
Five-year Government of Canada bond yields rose three basis points last week, closing at 0.74% on Friday. Five-year fixed-rate mortgages are available in the 2.29% to 2.39% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at about 2.49%.
Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: OSFI’s recent announcement, innocuous as it might have seemed to the casual observer, was a warning to lenders that it has the power to quickly change their business model, and by association, our mortgage rates, at both the industry and individual level. For now, it’s business as usual, but lenders just got another reminder that OSFI can make the cost of negligence very expensive if needed.