Economy & Markets

The co-ordinated measures aim to dampen some of the froth that has built up in Canada’s housing market in recent years

By James Langton |

The federal government and financial regulators are taking several measures designed to curb the rising risks relating to Canada's housing market, including increasing down payment minimums, boosting the capital that banks and mortgage insurers must hold against their residential mortgage exposure and raising the cost of securitizations.

The federal Department of Finance Canada, the Office of the Superintendent of Financial Institutions (OSFI) and the Canada Mortgage Housing Corp. (CMHC) announced a co-ordinated series of measures on Friday that aim to dampen some of the risks that may be building up given the froth in Canada's housing market in recent years.

To start, the federal government announced that it's increasing the minimum down payment for mortgages to qualify for government insurance to 10% from 5% for the portion of the house price above $500,000. The minimum down payment remains 5% below the $500,000 mark. The new measure is slated to take effect Feb. 15, 2016 and it will not impact existing mortgages.

Finance Minister Bill Morneau announced the change to the mortgage insurance rules on Friday, saying that they're designed to "contain risks in the housing market, reduce taxpayer exposure and support long-term stability."

The change to down payment minimums, Morneau said, "will increase homeowner equity, which plays a key role in maintaining a stable and secure housing market and economy over the long term. It also protects all homeowners, including many middle class Canadians whose greatest investment is in their homes."

At the same time, Morneau also noted that the Office of the Superintendent of Financial Institutions (OSFI) is boosting capital requirements for residential mortgages and that CMHC is increasing the guarantee fees for securitization programs.

OSFI announced in a letter issued on Friday that it's planning changes to the capital requirements for residential mortgages to better reflect the risks that have developed in this end of the market.

"Risks in the Canadian mortgage market continue to evolve. Household debt continues to grow faster than income and housing prices in some markets continue to rise rapidly," OSFI's letter notes. "The planned changes to the regulatory capital framework will ensure that capital requirements keep pace with those developments and reflect underlying risks."

The OSFI letter says the changes will be worked out, in consultation with the industry, over the coming year and that the regulator plans to have final rules in place by 2017.

The changes will affect the regulatory capital requirements for banks that are using internal models for mortgage default risk and private mortgage insurers that rely on standardized capital requirements.

For banks that are using internal models, OSFI says that it will propose "a risk-sensitive floor" as one of the model inputs "that will be tied to increases in local property prices and/or to house prices that are high relative to borrower incomes. This will ensure a level of consistency and conservatism in the protection provided to depositors and unsecured creditors."

For private mortgage insurers, OSFI plans to introduce a new standardized approach that "updates the capital requirements for mortgage guarantee insurance risk. It will require more capital when house prices are high relative to borrower incomes. This will ensure a level of conservatism in the protection provided to policyholders and unsecured creditors."

OSFI also suggests that concerns about the adequacy of mortgage loan documentation may lead to higher capital requirements too. Banks currently enjoy "very low capital requirements" on insured mortgages, but that it is now considering "additional criteria for recognizing the capital benefits of mortgage insurance in light of recent observations related to mortgage loan documentation," OSFI's letter notes.

"The risk mitigation benefits of mortgage insurance for regulatory capital purposes should, in principle, be reduced in circumstances where there may be material concerns around compliance with the terms of the insurance policy," the letter adds.

Despite these planned changes, OSFI also indicates that the situation is not dire. It stresses that the current capital requirements "already contain an appreciable degree of conservatism" when it comes to residential mortgages.

"These proposed updates to regulatory capital requirements reflect a measured and forward looking response to changing risks in the Canadian mortgage market," the OSFI letter adds. "They will be applied on a go-forward basis to new mortgage loans."

Finally, the CMHC also announced on Friday that it's revising the fees it charges issuers of mortgage-backed securities (MBS) and mortgage bonds in order to guarantee these securities.

"The revised fee structure is intended to encourage the development of private market funding alternatives by narrowing the funding cost difference between government sponsored and private market funding sources," said Wojo Zielonka, senior vice president, capital markets, with CMHC, in a statement.

Starting July 1, 2016, the threshold for an issuer's annual MBS guarantees will be increased from $6 billion to $7.5 billion, and the fee charged for five-year MBS above that threshold will increase to 80 basis points (bps) from 60 bps.

"The higher guarantee fee for issuances beyond the threshold is designed to discourage excessive use of MBS for liquidity or funding purposes," CMHC says.

Furthermore, the CMHC reports that the annual limit for new MBS is being raised. Specifically, the CMHC says that the Minister of Finance has authorized it to provide up to $105 billion in new MBS guarantees in 2016, up from $80 billion in 2015; and up to $40 billion in new guarantees for mortgage bonds (unchanged from 2015). The limit on MBS is being raised, it says, to accommodate the fact that MBS can be used in mortgage bonds starting July 1.