Canadian banking regulator, the Office of the Superintendent of Financial Institutions (OSFI) has announced a consultation on proposed changes to the Capital Adequacy Requirements (CAR) and Mortgage Insurer Capital Adequacy Test (MICAT) guidelines.
These changes will help banks and mortgage insurers address risks related to mortgages in negative amortisation. That is, where payments are insufficient to cover the interest portion.
The consultation period runs until 1 September.
Specifically, the regulator is concerned about the growing popularity of variable rate mortgages. Such loans track the central bank overnight rate. The product is popular in a low interest rate environment. As rates rise, some borrowers have not paid the full amount of interest owed each month.
The unpaid interest is added to the principal – negative amortisation. As a result, as the sum outstanding grows, the lender extends the period for repayment.
According to the OSFI, for lenders the proposed changes will mean holding more capital that aligns with the increased risk of mortgages in negative amortisation with a loan-to-value ratio (LTV) above 65%.
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In other words, the outstanding balance is 65% or more of the value of the collateral. The proposed changes should encourage banks to lessen the number of mortgages that would otherwise go into negative amortisation.
For mortgage insurers, the maximum LTV ratio for an individual mortgage in the MICAT capital formula will increase from 100% to 105%. This change aligns the MICAT capital formula with the maximum permitted LTV ratio for insured mortgages.
OFSI goal: ensure banks and mortgage insurers manage risk
For consumers who have a current mortgage term, these changes will not lead to an increase in monthly payments.
In its second quarter earnings presentation, Royal Bank of Canada reported that Canadian retail mortgages grew by 7% y-o-y. That was down from 8% y-o-y growth in the prior quarter. RBC said that origination activity is expected to continue moderating towards 2019 levels as limited supply and increased demand from immigration is muted by concerns around affordability. RBC expects annual mortgage growth to slow to the mid-single digits in the remainder of 2023.