The federal government’s new mortgage stress test was responsible for a drop of as much as $15-billion in residential mortgage borrowing last year, according to a report to be released Tuesday.
Benjamin Tal, deputy chief economist at CIBC World Markets Inc., argues that the 2018 rule change was the biggest factor in an 8-per-cent drop in new mortgage originations in Canada last year over 2017 – about a $25-billion decline in lending activity. He estimates the stress test accounted for 50 per cent to 60 per cent of the decline, or about $13-billion to $15-billion, with the rest attributable to factors such as rising interest rates and the lack of affordability in major markets.
His review concluded that about 93 per cent of the overall drop was due to fewer borrowers taking out loans, with just 7 per cent due to people borrowing less on average because they could not qualify for larger loans under the new rules.
The government’s stress test, part of the B-20 guideline for mortgage lenders, took effect Jan. 1, 2018, and requires borrowers to prove they could still afford their mortgage payments even if interest rates were two percentage points higher than the rate they negotiated with their banks.
Home sales in Canada fell 11 per cent last year – led by a 32-per-cent drop in the Vancouver region – as buyers sat on the sidelines in many major markets. Industry experts blamed much of the weakness on the new stress test, which left many buyers unable to qualify for mortgages. But Mr. Tal’s report attempts to isolate and quantify the impact.
The market weakness has continued into 2019, with national home sales dropping 4.6 per cent in March compared with the same period last year, according to a report Monday from the Canadian Real Estate Association. CREA said sales were the lowest for any March since 2013 as many buyers remained sidelined by the stress-test rule.
The number of homes sold in the Vancouver region was down 34 per cent in March compared with a year ago, while sales in the Greater Toronto Area were flat, dropping 0.1 per cent on a year-over-year basis.
Mr. Tal said he supports the need for the stress test, which has worked as intended to slow the rate of higher-risk borrowing, especially in expensive markets such as Toronto and Vancouver. But he said it may be time to consider relaxing the criteria because it’s “a bit too severe at this point in the game.”
“I’m not saying to kill B-20 by any stretch of the imagination," he said in an interview. “I’m just saying it should be a bit more flexible, and more dynamic, to reflect market conditions.”
For example, he said, the stress test doesn’t take into account the fact that interest rates have risen over the past two years, nor that typical borrowers will see their incomes rise over the course of their loan period. The test also doesn’t recognize that borrowers will see the principal amount of their mortgage fall as they make payments, reducing their risk.
He said there is “no real science” behind the decision to test mortgage affordability at two percentage points above the negotiated mortgage rate and added that Canada may need a narrower spread as interest rates rise. He said the government could also consider setting a fixed floor to test mortgage affordability – say, 4.5 per cent – that will not drop even if interest rates fall.
The CIBC report also offers details on the growth of private lending last year, as more borrowers turned to lenders who were not subject to the stress-test rule. From June to December, private lenders accounted for about 12 per cent of the number of new mortgage loans in Ontario, up from about 10 per cent a year earlier and 8 per cent in 2016, the report said.
Individual lenders accounted for slightly more than half of all private loans, while institutional mortgage investment corporations (MICs) accounted for the rest. One in five of the individual private lenders appeared to be family members – with the borrower sharing the same last name as the lender – while the rest appeared to be unrelated individuals providing the loans as investment opportunities, the report concluded.
Mr. Tal said the alternative lending market is an important element of the mortgage sector, but it is worrying that the industry is growing so quickly in the wake of the stress test. He said regulators should start paying more attention to what is happening.
“If you have a market that’s 7 or 8 per cent of the [mortgage] sector, I think it’s time to start looking at how we can regulate it. If it gets to 15 per cent, you want to be able to see what’s happening in 15 per cent of the market.”
Also on Monday, rating agency Fitch Ratings issued a report warning it expects home prices to fall modestly in several major countries that have seen rapidly rising consumer debt levels, including Canada, and said the debt risk poses a growing risk to major banks. But Fitch said its stress testing of possible economic outcomes in Canada shows the banks have resilience to “plausible but harsh scenarios.”
It said it would not expect “multi-notch” downgrades of major banks given this resilience, noting that average capital ratios did not fall significantly below regulatory minimums, even under its severe stress test scenarios.