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CMHC says latest stress test shows it could withstand major debt crisis - CMHC-says

CMHC says latest stress test shows it could withstand major debt crisis

PUBLISH BY: JANET MCFARLAND | October 2, 2018

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In the News

Canada’s federal mortgage insurer says it could withstand a significant household debt crisis that would lead to the failure of a major Canadian financial institution and an almost 50-per-cent drop in home prices.

Canada Mortgage and Housing Corp. (CMHC) released the results on Tuesday of its annual stress-testing exercise, measuring the potential financial effects on the agency if a series of severe events were ever to occur.

The most damaging scenario studied this year was a severe credit crisis that leaves households unable to pay their debts and causes the collapse of a major financial institution. Even if house prices were to drop by 46.7 per cent and unemployment levels were to rise to 10.5 per cent under the scenario, CMHC said it would still have adequate capital available to cover the risk.

While its base case assumes the agency will maintain a minimum regulatory capital level of 161.5 per cent of available capital compared to capital required, CMHC said that under a severe credit crisis scenario, its regulatory capital level would drop to 85.3 per cent, which is significantly less than its required minimum. Under federal regulations, mortgage insurers with capital levels less than 100 per cent may not be allowed to write new business, while a level less than zero indicates insolvency.

The agency would also remain profitable under the scenario, however, with CMHC projecting it would earn a cumulative net income of $4.8-billion for the 10-year period from 2018 to 2027.

The agency said the hypothetical events it studies are “extreme and unlikely,” but it needs to have internal action plans in case anything leads to a housing crisis that causes widespread mortgage defaults. CMHC insures lenders against borrowers defaulting on their mortgages, so it must ensure it has adequate capital reserves if mortgage defaults were to soar.

CMHC’s chief risk officer, Steven Mennill, said the agency seeks out “extreme, almost unimaginable situations” to examine how well it can withstand them.

“In all cases, this year’s stress testing shows we are well capitalized to handle these very severe situations,” he said in a statement.

In 2018, CMHC expanded its list of scenarios to include a household debt crisis, repeated cyberattacks on Canadian financial institutions and even a major volcanic eruption.

The agency modelled the potential outcome of severe cyberattacks on the Canadian financial system that cause severe disruption to business operations and have a material negative effect on the Canadian economy. Under the scenario, it predicts its minimum regulatory capital level would fall to 153.7 per cent. A global trade war that triggers an economic slowdown and rising unemployment would reduce capital levels to 157.3 per cent, CMHC said, while a severe volcanic eruption that disrupts global air travel and shipping and causes severe crop damage and food shortages – ultimately driving down home prices by 19.6 per cent – would reduce capital levels to 157.2 per cent.

The stress-test results were calculated on the assumption that CMHC will continue paying dividends to the federal government under all scenarios, but the agency said that, in a real crisis, it would actively seek to manage its losses and conserve capital to stabilize the housing markets.

Original Link: https://www.theglobeandmail.com/business/article-cmhc-says-latest-stress-test-shows-it-could-withstand-major-debt/

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