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Banking watchdog warns rising mortgage debt puts lenders at risk

Condos in the Gilmore area of Burnaby are seen in the distance behind houses in east Vancouver, B.C.

DARRYL DYCK/The Globe and Mail

The country's banking watchdog says lenders need to be more vigilant than ever as mortgage debt rises.

"That growth in mortgage debt is particularly evident among highly indebted households – households that have less capacity to cope financially with a loss of income or an increase in interest rates," said Jeremy Rudin, Canada's superintendent of financial institutions.

Mr. Rudin said it is the job of the federal regulator that he heads, the Office of the Superintendent of Financial Institutions (OSFI), "to get out in front of the risks" encountered by lenders and mortgage insurers, which could suffer significant losses should there be a lengthy economic downturn.

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"Recognizing these elevated financial risks and vulnerabilities facing the Canadian financial institutions, we at OSFI issued a letter to the industry in July of this year. And in that letter, we indicated that we were tightening our expectations and increasing scrutiny around residential mortgage underwriting practices," he said in a speech Monday at the national conference for Mortgage Professionals Canada, which represents mortgage brokers.

In October, Canada Mortgage and Housing Corp. issued its "red warning" for the country's real estate market as a whole. The federal agency cautioned that with many suburbs near Vancouver and Toronto already seeing prices spike, pressure is spreading even farther out as some buyers search for homes in bedroom communities such as Abbotsford, B.C., and Barrie, Ont.

Analysts expect British Columbia and Ontario to account for about two-thirds of this year's Canadian sales of existing residential properties.

"The recent uptick in mortgage rates should serve as a reminder that low rates are not a given, especially over longer periods of time," Mr. Rudin said.

"Sound underwriting has always been important, but it has never been as important as it is now. Virtually everyone who is involved in mortgage origination in Canada has a role to play in supporting sound underwriting practices, the sound practices that we require of the federally regulated institutions."

In instances when some housing markets do experience price declines, there haven't been severe drops, he said.

"Lenders might be led to believe that weak underwriting standards will be mitigated by ever-rising collateral values. Our view is the opposite," Mr. Rudin said. "In these circumstances, prudent lenders put less emphasis on collateral values, not more."

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During a news conference after his Vancouver speech, Mr. Rudin said it is also important for lenders to verify a borrower's income and employment.

"These can still be reasonable risks. What we're looking for is real effort – reasonable but nonetheless – to verifying income and employment in those more challenging circumstances, whether they're domestic or foreign," he said.

The B.C. government implemented a 15-per-cent tax on foreign buyers in the Vancouver region, starting in August.

While prices in the Vancouver region have fallen recently, the market remains expensive. The price of detached houses sold recently within the City of Vancouver averaged more than $2.6-million, or double the average price for detached properties in the City of Toronto.

In June, the federal government established a working group to recommend ways to make housing more affordable in Canada's two most expensive real estate markets. For various property types in the Greater Toronto Area, the price averaged a record $762,975 in October, up 20.9 per cent from a year earlier. In Greater Vancouver's softening market, the average price for detached houses, condos and townhomes sold in October dropped to $891,705, or a 5.9-per-cent decline from the same month in 2015, according to the Canadian Real Estate Association.

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