Banks stand at mortgage ‘deferral cliff’

Results begin Tuesday

TORONTO • When Canada’s biggest banks last reported financial results in February, executives said it was too early to tell what kind of effect COVID-19 would have on their business. That there will be some effects is no longer in doubt.

In three months, the coronavirus has gone from distant threat to clear and present danger, with the lockdowns to slow the spread of the disease plunging the global economy into an historic recession. To avoid a wave of defaults, banks have allowed more than 700,000 Canadians to skip or defer mortgage payments since March, or about 15 per cent of the total mortgages in their portfolios, according to the Canadian Bankers Association.

Those measures were announced with little discussion about what they meant for the bottom line. Questions about cost, the make-up of the borrowers seeking deferrals, and what could happen after deferral periods end were a lower priority than preventing insolvencies.

That will change this week when the Big Six banks report earnings for the quarter ended April 30, starting with Bank of Nova Scotia and National Bank of Canada on Tuesday. Canada Mortgage and Housing Corp. CEO Evan Siddall offered a reminder last week of the sort of risk facing the banks (as well as mortgage-default insurers like CMHC), telling the House of Commons finance committee that nearly 20 per cent of mortgage holders could be deferring payments by September.

“A team is at work within CMHC to help manage a growing debt 'deferral cliff’ that looms in the fall, when some unemployed people will need to start paying their mortgages again,” Siddall told the committee. “As much as one fifth of all mortgages could be in arrears if our economy has not recovered sufficiently.”

Mortgages have been a key source of profits for the banks for years, so it’s likely that analysts will want to know more about mortgage deferrals or any sort of “deferral cliff” when executives take questions about their results. Bank of Montreal and Royal Bank of Canada will report quarterly earnings on May 27, followed by Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on May 28.

The results will be a bumpier ride than usual for shareholders who have become accustomed to steady earnings growth. COVID-19 and the collapse of oil prices will have hit the results of lenders hard, although not so hard that any of the banks are likely to record losses.

“What we as analysts will want to know is what pattern are the banks seeing in terms of who’s asking for deferrals, from what regions, what are the general characteristics of … the households asking for deferrals,” Cormark Securities’ Meny Grauman said in an interview.

Grauman noted some of the smaller financial institutions that have already reported their earnings saw a “broad swath” of customers seeking deferrals, not just the most financially distressed ones.

This could suggest some customers may be deferring payments to preserve cash or, perhaps, just because they can. Equitable Bank CEO Andrew Moor said earlier this month that they’d been hearing anecdotal evidence of people saying they’d like to “reverse” deferrals and start making payments again.

“There is no question that the mortgage market will have some difficulties,” Jeremy Rudin, Canada’s Superintendent of Financial Institutions, told the finance committee last Thursday. “It’s too soon to say that all of these deferrals will turn into delinquencies. There are certainly people who have asked for deferrals who will be able to be current, but certainly there will be some that do not.”

National Bank Financial analyst Gabriel Dechaine forecast earlier this month that the average common equity tier 1 ratio of the Big Six — a measure of the high-quality capital that the lenders hold relative to their lending — would dip to 11.3 per cent as of the end of April. This would be down from 11.6 as of the end of January, but still well above the nine-per-cent regulatory minimum.

Early expectations among analysts is that second-quarter profit will be sapped by loan-loss provisions and tighter money-making margins. Canaccord Genuity analyst Scott Chan said they’re forecasting earnings per share for the Big Six to decline 51 per cent over the previous quarter, similar to what U.S. regional banks reported.

BMO Capital Markets analyst Sohrab Movahedi said loan-loss provisions among eight of the biggest banks are expected to increase 287 per cent yearover-year for their second quarter, to approximately $8.9 billion.

“Given the unprecedented level of support (government and bank-sponsored COVID-19 relief programs) targeting the consumer, we believe loan loss reserve building will largely be within the corporate and commercial book rather than the retail portfolios,” Movahedi wrote in a recent report.

Credit will indeed be the “main event” for the quarter, Grauman said, although provisioning for losses will mostly be for loans that are still considered to be performing, or being paid back. This is due in part to the accounting for expected credit losses that the banks use, which is influenced by nowgrim economic forecasts.

“That plus the unprecedented impact of the lockdown will mean that we’ll probably see the biggest uptick in loan-loss provisions on a percentage basis that we’ve ever seen in the history of the Canadian banks,” Grauman said.