Canadian banks are well positioned should a housing collapse, like the one that catalysed the Great Recession, occur here.
With ever-rising housing prices and increased mortgage lending, especially in Toronto and Vancouver—the two most expensive markets in the country—the fallout from a collapsed housing market would be substantial.
However, according to Moody’s Investors Service, while the losses would be high, government, regulators, and Canadian banks have instituted protective measures, including larger capital buffers, over the last couple of years that would avert a calamitous economic event because of the latter’s ability to absorb losses.
“Banks are in better shape than two years ago,” Jason Mercer, a senior analyst at Moody’s, was quoted as saying in the Vancouver Sun. “Our stress results indicate banks would experience higher losses…because house prices have continued to increase and mortgage loans have grown. However, the banks have increased their capital buffers during that time and are now in a stronger financial position to weather such losses.”
The Moody’s stress test determined that aggregate losses would reach $14.3bln for Canada’s seven largest mortgage lenders—up from $12.1bln in 2016. A contributing factor is growth of uninsured mortgages, which have higher losses in default.
Losses would have accounted for 60 basis points of the banks’ CET1 capital—which is a protective buffer closely monitored by regulators—in 2016, however, according to the latest stress test, potential losses have climbed to 70 basis points. But because the CET1 starting point is significantly higher, increased losses would be offset.
Moody’s also noted that CIBC would have the lowest “post-stress” capital, with its CET1 ratio of 10% being the result of its large domestic franchise.
As housing prices have climbed throughout the country, A-lenders have been lending homebuyers more money. Between 2014 and 2017, the average house price in the country surged nearly 10% annually, and residential mortgage debt increased at a compound annual growth of 6%. Moreover, roughly half of domestic banking assets are residential mortgages.
Home equity lines of credit are steadily growing but, at 16%, they’re shrinking as a proportion of mortgage-related debt. Nevertheless, HELOCs are an area of concern because homes are used as collateral and heavily indebted consumers could be left exposed in a rising rate environment, or by sliding home values.
HELOCs “increase consumer vulnerability because they extract home equity and shrink borrowers’ buffer against a (potential) rapid house price correction,” said the Moody’s report.
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