Canada’s banking regulator is seeing a spike in highly indebted mortgage borrowers. The Office of the Superintendent of Financial Institutions (OSFI) observed renewed growth in the exposure of mortgages to “over-leveraged” households in Q4 2020. Low interest rates are fueling rapid growth in borrowing — for both quantity and size. The share of mortgages going to over-leveraged borrowers blew past the pre-B-20 highs. It now sits at the highest share of originations on record.
How Much Is Over-leveraged?
OSFI uses the loan-to-income (LTI) ratio to determine segments of indebtedness. If a borrower has a mortgage LTI of 450% or more, they’re “highly indebted” or “over-leveraged.” This means their mortgage debt is at least 4.5 times the borrowers income. Ideally, the ratio of these borrowers falls, lowering risk.
When this ratio rises, risk increases, setting off regulatory radars. High levels often precede overly easy lending, which can become a problem. When regulators call it out, it often precedes new regulations to lower debt — like it did in 2017.
Over-leveraged Borrowers Represent A Record Amount of Leverage
OSFI mortgage lenders are seeing a record share of originations go to borrowers with LTI of 450% or more. These highly indebted borrowers represented 22.68% of originations in Q4 2020. The share of the market in that quarter was 5.19 points higher than just a year before. This is a very quick rise, which B-20 Guidelines had reigned in a few years prior. That’s a fast deterioration, rendering the impact of previous cooling measures obsolete.
Canadian Uninsured Mortgage Originations To Highly Indebted BorrowersThe percent of uninsured mortgages at OSFI regulated lenders, to borrowers with a loan to income ratio higher than 450 per cent. Source: OSFI, Better Dwelling.
If this sounds foreign to you, B-20 Guidelines are what created the uninsured “stress test.” OSFI required banks to test borrowers for the ability to pay bills at higher interest rates. Almost immediately after rolling out the guidelines, highly indebted borrowers dropped off dramatically.
As we mentioned before, this trend had been reversing before the pandemic. The ratio increasing is a typical part of normalization, after a policy shock. Cheap credit from the pandemic accelerated the growth trend though, pushing it past the previous level of concern. Complicating the issue further, is the fact mortgage volumes today are also likely much higher than they were a few years ago.
On a positive note, or less negative — the debt servicing of these borrowers improved. Over-leveraged borrowers had an average total debt service ratio (TDS) of 43.57% in Q4 2020. This is down from the recent peak average TDS of 45.99% in Q1 2019. Historically low rates are behind the trend, likely making it temporary. When rates rise again, servicing costs are likely to push higher as well.
The regulator has said they’re watching the situation, and plan on acting as needed. Considering even banks are now asking for market cooling measures, that may be soon.
Like this post? Like us on Facebook for the next one in your feed.