Banks ‘in better shape than two years ago’
TORONTO • Surging house prices and increased mortgage lending by Canada’s biggest banks — particularly in hot regions around Vancouver and Toronto — have boosted potential losses in the event of a U.S.-style housing crisis, according to the latest stress test by Moody’s Investors Service.
But steps take by governments and regulators, and by the financial institutions themselves, mean the banks are in a stronger position to absorb such losses than they were in 2016.
“Banks are in better shape than two years ago,” said Jason Mercer, a senior analyst at Moody’s and lead author of the ratings agency’s report released Wednesday.
“Our stress results indicate banks would experience higher losses … because house prices have continued to increase and mortgage loans have grown,” Mercer said.
“However, the banks have increased their capital buffers during that time and are now in a stronger financial position to weather such losses.”
Aggregate potential mortgage losses for the seven largest Canadian mortgage lenders, which include the country’s Big Five banks, have climbed to $14.3 billion in the Moody’s stress test, up from $12.1 billion in 2016. A “shift in portfolio mix” in favour of Ontario and B.C. contributed to higher assumed loss rates, as did an increasing proportion of uninsured mortgages, which have higher losses in default, Moody’s said.
In the two years since the credit ratings agency’s last stress test, all the banks have amassed larger capital buffers that would absorb the additional losses and leave the financial institutions in a stronger position.
The potential losses would consume about 70 basis points of the banks’ CET1 capital, the protective buffer that is closely watched by regulators. While the potential impact is up from 60 basis points in the 2016 stress test performed by Moody’s, the ratings agency notes that the starting point CET1 capital “is now materially higher, more than offsetting the increased losses.”
Canadian Imperial Bank of Commerce remains the lender that would have the lowest “post-stress” capital — with a CET1 ratio of 10 per cent — due to its large domestic franchise, according to Moody’s.
Canada’s biggest banks have increased their lending to home-buyers in recent years as house prices have climbed. Between 2014 and 2017, the average house price in Canada grew by almost 10 per cent a year, according to Moody’s. During the same period, residential mortgage debt increased at a compound annual growth rate of six per cent, reaching almost $1.8 trillion.
Roughly 50 per cent of domestic banking assets are residential mortgages, according to Moody’s.
But the report noted several changes that ease consumer debt concerns and bank exposure. For example, home equity lines of credit, or HELOCS, are still growing, but they are shrinking as a proportion of mortgage-related debt, standing at about 16 per cent.
A higher amount of consumer debt in HELOCs is a concern because the interestonly unamortized loans use the home as collateral. This gives consumers an easier path to carry debt, which can leave them exposed to external circumstances such as an increase in interest rates or a steep decline in house values.
As Moody’s notes in the report, HELOCs “increase consumer vulnerability because they extract home equity and shrink borrowers’ buffer against a (potential) rapid house price correction.”
HELOCs can also be called at any time, though Mercer says this is unlikely to occur if borrowers are making their monthly payments.
Moody’s notes that unemployment has remained historically low since its last stress test, which is positive for residential credit quality. In addition, government and regulatory intervention appears to be taking some of the wind out of home price growth, while high consumer debt relative to income also appears to be moderating with the strong labour market helping to raise incomes.
A STRONGER FINANCIAL POSITION TO WEATHER SUCH LOSSES.