National Bank analyst expects two headwinds to hit the Canadian housing market if the new rules go head: higher mortgage rates and a higher probability that foreclosures will increase.
Residential mortgage default insurance premiums are likely to increase for homes in hot real estate markets as a result of beefed-up capital requirements for Canada’s mortgage insurers coming into force next year.
And it is homebuyers who are expected to bear the added cost, rather than the financial institutions that lend the money for home purchases, according to Peter Routledge, an analyst at National Bank Financial
“We believe Canadian homebuyers will absorb the bulk of these higher costs directly or indirectly via higher mortgage interest rates,” Routledge said in a note to clients Monday.
“Said differently, we do not expect a material impact on bank or mortgage lender earnings strictly as a result of higher mortgage insurance premiums.”
The capital changes proposed last week by the Office of the Superintendent of Financial Institutions require added consideration of factors including the credit score, outstanding loan balance, and amount of time left to fully repay the mortgage for those who require default insurance. The new rules are to come into effect Jan. 1 following a consultation period, and are intended to account for risks in hot real estate pockets across the country including high price-to-income ratios.
Genworth MI Canada Inc., the parent company Canada’s largest private residential mortgage insurer, issued a statement Friday that said the company expects it will compliant with the new framework, “subject to business and market conditions.” The mortgage insurer estimates its pro forma minimum capital test ratio as of June 30 at between 153 per cent and 156 per cent, above OSFI’s target of 150 per cent.
Routledge said he expects two headwinds to hit the Canadian housing market if the OSFI mandated changes go ahead as proposed: higher mortgage rates and a higher probability that foreclosures will increase. The combined impact could contribute to a cooling of the market.
“Mortgage insurance premium increases passed on to the homebuyer through higher mortgage interest rates will reduce affordability, potentially stunting sales activity and slowing house price appreciation,” the analyst wrote.
He said higher mortgage insurance premiums would hit the first-time homebuyers hard, as well as the mortgage broker channel that relies on this group. As a result, he believes, mono-line mortgage lenders that originate prime insured mortgages through the broker channel “are most at risk to a slowdown in sales activity directly related to higher mortgage insurance premiums.”
In fact, since the Bank of Canada began inflation targeting 25 years ago, core inflation has never exceeded the Bank’s 3-per-cent upper limit for more than six months at a time. In those past bouts with inflation, interest rates jumped just more than three percentage points from their cycle lows, on average. But rates never remained at those inflated levels for more than a few years.
The analyst said the new rules could also serve to crimp the practice of extending the amortization period of a mortgage to reduce monthly payments when a borrower is in financial distress. This is because, under the new framework, more capital would have to be set aside against those mortgages.
“In our view, this weakens the incentive for mortgage insurance companies to forbear, potentially increasing the likelihood of foreclosure,” Routledge wrote. An increase in the number of properties in foreclosure proceedings, in turn, would weigh on home price appreciation, the analyst said.
He noted that increased mortgage insurance costs triggered by the new rules could also drive demand for uninsured mortgages.