CMHC Stress Testing Confirms Ability to Withstand Extreme Scenarios
OTTAWA, November 17, 2016 — In support of greater transparency with respect to risk management practices, CMHC released today the results of its 2016 stress testing exercise. None of the scenarios tested should be considered a prediction or a forecast.
“Stress testing involves searching out extreme scenarios that have a very remote chance of happening and planning for them,” said Romy Bowers, CMHC’s Chief Risk Officer. “Rigorous stress testing is an essential part of our risk management program and allows CMHC to evaluate its capital levels against these scenarios.”
This year’s tests confirm that CMHC’s capital holdings are sufficient for even the most extreme scenarios.
In 2016, CMHC tested its mortgage loan insurance and securitization businesses against several extreme scenarios including:
- Global economic deflation
- Sustained low oil price shock
- High-magnitude earthquake
- Reverse stress test
- U.S. style housing correction
Additional details on these scenarios are included in the backgrounder below.
The results of each scenario on CMHC’s regulatory capital requirements (% MCT) are as follows:
|For the 2017-2021 Period
||Oil Price Shock
||Reverse Stress Test
||US Style Housing Correction
|Peak unemployment rate
|Change in housing prices
|Cumulative net income/loss - Insurance
|Lowest Insurance capital (% MCT) – current MCT
|Lowest Insurance capital (% MCT) – new MCT
|Cumulative net income - Securitization
|Lowest point of available capital - Securitization
Business resumption exercises involving participation across a number of departments are routinely carried out as part of CMHC's stress testing program with results reported internally to senior management and the Board. Outcomes from the exercise are valuable towards development of effective business continuity plans ensuring CMHC's continued ability to deliver on its mandate.
As Canada’s authority on housing, CMHC contributes to the stability of the housing market and financial system, provides support for Canadians in housing need and offers objective housing research and information to Canadian governments, consumers and the housing industry.
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- CMHC follows the guidance set by the Office of the Superintendent of Financial Institutions (OSFI) with respect to stress testing. CMHC also develops its own stress testing cases for business planning purposes.
- The Minimum Capital Test (MCT) is the ratio of capital available to capital required. Below 100% MCT, an insurance company may no longer be allowed to write new business. A level below 0% MCT indicates insolvency.
- On September 23, 2016 OSFI released for comment a draft advisory updating the capital requirements for residential mortgage insurance risk. The table above reports CMHC’s lowest Insurance capital (MCT) under both the current capital framework and based on CMHC’s understanding of the new draft advisory.
- The new MCT, which will be implemented on January 1, 2017, is more risk-based and incorporates additional risk attributes such as credit score, remaining amortization and outstanding loan balance. It is important to note that further changes to the new framework may be made as it continues to be finalized by OSFI.
- The underlying variables within each of the stress testing scenarios were developed based on a combination of hypothetical and historical economic analysis.
||Non-stressed situation according to CMHC’s Corporate Plan.
||Severe and prolonged economic depression.
|Oil Price Shock
||Price of oil falls to US$20 per barrel in 2017 and subsequently ranges between US$20-30 for further four years.
||Multiple scenarios of a high-magnitude earthquake that disrupts critical infrastructure and services in a major urban centre, including broader financial impacts as a result of its effects on homeowners and businesses, were run. Reporting reflects the most severe outcome of the simulations.
|Reverse Stress Test
||A sudden increase in interest rates leads to higher borrowing costs for both Canadian consumers and financial institutions, causing a severe drop in Canadian house prices and ultimately the failure of a Canadian financial institution.
|US Style Housing Correction
||A 5 percentage point increase in the unemployment rate with a 30% decline in house prices.