Stress Test Changes Halted

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We made an statement in another post acknowledging the seriousness of the COVID-19 situation, and a commitment to stick to what we know (mortgages) and what’s relevant (how it affects you). For that reason, this post will dive right into the subject.

The Office of the Superintendent of Financial Institutions (OSFI) has halted to changes to the stress test that were supposed to take effect on April 6th. Admittedly, we were surprised, but on further digesting everything going on, it makes perfect sense.

In its announcement, OSFI cited its intent “to support the resilience of financial institutions” and the “critical need for strong capital and liquidity and effective risk management.” Translation: right now is a time when we need a strong financial system, strong banks with strong balance sheets, and strong consumers not taking on more mortgage than they can afford.

Is it also perhaps a foreshadowing that the increased risk to lenders could mean higher fixed interest rates? Well, we’re already starting to see it. One of our bank partners last week had a market leading low 5 year fixed interest rate, and that same lender was the first out of the gate to reverse course. Their unadvertised 5 year fixed special jumped by a shocking 0.25% overnight with only hours’ notice. Other lenders quickly followed suit, but not all have.

What drives fixed rates?

The drop in fixed mortgage rates still hasn’t caught up to the recent absolutely stunning drop in the bond rate, and up until the added shock to the market last week, we were expecting further drops in fixed rates. That could still happen, and some lenders have kept going with the decreases, but we would not be at all surprised to see an outright reversal. Whether that happens or not, and whether further decreases happen before then, is impossible to say. There’s too much happening. But generally speaking, the 5 year Canada government bond rate drives fixed mortgage rates. We use this rate as a guide for what to expect with fixed rates. The rapid and dramatic decline in bond rates saw a stunning decline in 5 year fixed mortgage rates across Canada.

But we have to remember that credit risk (can people actually repay this money) and liquidity (availability of money) are also key factors. If you’re someone who controls hundreds of millions, or billions, of dollars to invest in mortgages, you’re probably going to care a lot about all the economic, market, and employment uncertainty. You might be a little skittish. And you might think, sure, I’ll lend that money, but I think I should charge more because there’s an increasing chance I won’t see my money back or that payments will be late.

So why halt the stress test changes?

Well, as OSFI said, it wants to support the “resilience of financial institutions”. Introducing changes that – 1) are not fully developed and with many questions remaining mere weeks before implementation and 2) are not well timed, given all that is going on – seemed like maybe not the best idea.

Market participants (mortgage borrowers, lenders, default insurers, banks, and so on) are already accustomed to the current stress test rate and how it works. While the way the rate is calculated (the mode average of the Big 6 Banks’ posted 5 year fixed mortgage rates) isn’t ideal, it is a lot simpler than the new way is was going to be calculated. OSFI’s and market participants’ resources are going to be needed to deal with much more pressing issues than sorting out the finer points of the new stress test.

OSFI also changed the Domestic Stability Buffer from 2.25% of risk weighted assets, to 1.00%. The domestic stability buffer was a rule that forced banks to hold capital on their balance sheets to allow for a rainy day in the event of major economic disruption. By reducing this number, it frees up more capital for banks to do what they do – lend money.

In its announcement, OSFI is trying to address credit risk (by keeping the stress test a little harder than it was set to be as of April 6) and liquidity (by loosening up capital requirements for big banks) the hope is to keep money flowing, but also to keep the eye on the prize of keeping consumer indebtedness under control. A tight rope walk if there ever was one, especially in these times.


Talk to us any time with all of your questions. That’s what we’re here for!

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