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Business Briefing Economists question severity of Canada’s mortgage stress tests

Briefing highlights

  • Economists question stress test levels
  • Stocks, loonie, oil at a glance
  • BCE boosts dividend, profit slips
  • Europe’s economic outlook dims
  • Bank of England holds rate steady ...
  • ... but warns of slower economic growth
  • CNRL a partner in Total discovery
  • Germany restricts Facebook data gathering
  • Twitter lags forecast estimates
  • From today’s Globe and Mail

Stressed

At least two Bay Street economists are raising fresh questions about the severity of Canada’s year-old mortgage-qualification stress tests.

Both Benjamin Tal of Canadian Imperial Bank of Commerce and Robert Kavcic of Bank of Montreal stopped short of calling for a change in the federal bank regulator’s rules but did question whether the stress test levels are the right ones, given where things stand now.

“We do not view the original move by the regulator to raise the qualification rate by 200 basis points as an error,” said Mr. Tal, CIBC’s deputy chief economist.

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“Some Canadians needed to be saved from themselves,” he added in a recent report.

“But given where we are in the cycle, and with policy rates up by 75 basis points since the introduction of the new measures, is 200 basis points still the right number? Not taking a position here … just asking.”

By policy rates, Mr. Tal was referring to the Bank of Canada’s rate increases, which have since come to a sudden halt amid economic uncertainty.

As for the qualification rate, he was referring to the stress test the bank regulator, the Office of the Superintendent of Financial Institutions, put into effect in January, 2018.

Known as B20 rules, they were aimed at heading off a credit bubble amid swollen household debt burdens and frothy housing markets.

They force people who want a new uninsured mortgage to demonstrate they can juggle payments at rates two percentage points above what’s being offered by a lender.

The new rules indeed cooled household borrowing and took the heat out of some of the overpriced housing markets.

“In Canada, the damage caused by the central bank’s premature bullishness was reversed quickly,” Mr. Tal said of the Bank of Canada’s earlier path for raising rates.

“What hasn’t been reversed yet is the damage to the housing market due to OSFI’s B20 rules – the change in mortgage-qualification criteria.”

As Mr. Kavcic put it, the new rules were, at the time, when interest rates were at ultra-lows, “designed to desensitize households” to the fact that they would eventually rise to a more normal level.

Back then, adding two percentage points to the Bank of Canada’s benchmark would have brought that rate to the “low end” of a range the central bank deemed neutral, the BMO senior economist said.

“So, while the BoC is still plodding its way to neutral, the residential mortgage market is now, at least from a qualification perspective, well into restrictive territory,” he added.

“You can see this as well by looking at the five-year fixed mortgage rate – adjusting it for OSFI lifts the qualifying rate well above the long-run highs.”

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Of course, this isn’t the rate borrowers actually pay, but rather what they have to prove they can meet to qualify, so the effect isn’t as “severe” as you might think.

And borrowers might not actually be affected at all “if you are shopping well below your limit,” Mr. Kavcic said.

“But, with the well-purposed spirit of the measure in mind, there might be a case to be made for the qualification rate to be scaled back in lock-step with underlying rate increases, especially now with those rates near neutral.”

The rules have, of course, been controversial. And OSFI has been defending them.

Indeed, just this week, OSFI’s Carolyn Rogers, assistant superintendent for regulation, rebutted various criticisms point by point.

“The stress test is, quite simply, a safety buffer that ensures a borrower doesn’t stretch their borrowing capacity to its maximum, leaving no room to absorb unforeseen events,” Ms. Rogers said.

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“This is simply prudent. It’s prudent for the bank and it’s prudent for the borrower, too.”

Carolyn Rogers

The Canadian Press

She addressed the issue of rising rates, and whether that should mean a change for the stress test level, but said there’s more to consider.

“The simple design of the stress test – adjusting the interest rate upward for the purposes of qualifying a borrower’s capacity – might make it look like it’s simply there to front run a potential interest rate increase,” Ms. Rogers said.

“But borrowers face other risks that can impact their ability to pay their mortgage that I mentioned earlier: changes to income or changes to expenses other than their mortgage. It’s prudent to have a buffer for these changes, as well.”

And while rates have climbed, they’re still low, and debt is still high.

“A margin of safety in these conditions is prudent,” Ms. Rogers said.

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“Should that margin of safety be monitored, and should changes be considered if conditions in the environment change? Of course they should.”

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Markets at a glance

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BCE boosts dividend

BCE Inc. boosted its dividend today, boasting of a fourth quarter that “capped off a successful year of robust subscriber growth” and higher revenue.

BCE profit attributable to common shareholders slipped in the fourth quarter to $606-million, or 68 cents a share, from $698-million or 72 cents a year earlier, while revenue rose to $6.2-billion from $6-billion.

Adjusted earnings per share rose to 89 cents from 82.

The Canadian telecommunications giant also said it expects revenue to rise this year by between 1 and 3 per cent, with adjusted earnings per share of $3.48 to $3.58.

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It increased its dividend by 5 per cent to $3.17 a year.

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EU cuts forecasts

Europe’s economic outlook is dimming.

The European Commission today forecast economic growth of just 1.3 per cent for 2019, and 1.5 per cent for the wider European Union.

For 2018, it now sees expansion among the countries that use the euro at 1.6 per cent.

“Economic activity in the EU and the euro moderated last year on the back of a combination of internal and external factors,” the EC said in its quarterly outlook.

“While a moderation of growth was already in the cards, the slowdown in the second half of 2018 turned out to be more pronounced than expected.”

Notably, it now forecasts growth in Germany, Europe’s powerhouse economy, to ease to 1.1 per cent.

“Over the next two years, the economy is expected to continue growing but at a slower pace,” the group said of Europe in general.

“Outside the EU, activity is also slowing down amid high uncertainties, and the outlook varies for different parts of the world.”

Separately, the Bank of England held its benchmark rate steady at 0.75 per cent as it warned of slower growth of just 1.2 per cent this year.

The central bank cited both global economic growth and the turmoil surrounding Brexit.

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