Regulator advises lenders to mitigate risks after series of rate increases
Canada's banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), has issued an urgent call to lenders to address the risks associated with mortgage extensions.
The move comes as borrowers grapple with higher mortgage costs following the recent surprise rate hike by the Bank of Canada.
OSFI emphasized the need for a proactive approach to account management, specifically highlighting the resolution of negative amortization and the recognition of higher risk in loss provisioning.
"Our ongoing conversations with financial institutions have highlighted the importance of being proactive in managing all types of mortgage accounts, and to act before levels of borrower stress become unmanageable," OSFI said in a statement to Reuters.
The regulator had previously cautioned about the potential consequences of extending mortgage payment periods, noting that while it offered short-term relief to borrowers, it would prolong their debt burden.
In early 2022, roughly half of borrowers opted for variable-rate mortgages due to low-interest rates and lender discounts.
However, the number of borrowers choosing variable-rate mortgages declined significantly to 16.7% in January of this year, according to Canada's housing agency CMHC (Canada Mortgage and Housing Corporation).
As interest rates rise, mortgage payments no longer cover the interest portion, resulting in negative amortization.
Desjardins analyst Royce Mendes highlighted that the major Canadian banks reported over 20% of their mortgage portfolios with repayments exceeding 30 years in the first quarter, a consequence of non-amortizing variable-rate loans.
In contrast, the previous year saw only around 2% of mortgage portfolios fall into this category. Variable-rate mortgage holders are now facing substantial payment increases, leading some to consider extending their repayment periods.
Data from the Bank of Canada in May indicated that about one-third of mortgages experienced higher payments compared to February 2022, just before the central bank began raising interest rates.
The central bank anticipates that nearly all mortgage holders will see their payments increase.
While many banks have claimed that few customers opt for mortgage extensions, analysts caution that challenges will persist throughout the year.
"We continue to view mortgage lending as a moderate revenue headwind for the Canadian banks... with added risk to the economy as mortgages renew at higher rates, pressuring disposable income," said KBW analyst Mike Rizvanovic.
Furthermore, Canada's largest banks have set aside additional funds to cover potential bad loans in anticipation of increased defaults and weaknesses in commercial real estate.
"We believe risks are still elevated with the prospect of more rate hikes adding to the headwind on mortgage renewals," said Rizvanovic.
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