Canada – Page 2 – Digital Finance Analytics (DFA) Blog

Major Canadian Banks To “Open” Their Banking

According to Moody’s, on 11 January, the Canadian government published a consultation paper on its previously announced open banking initiative to foster competition within its banking industry. The initiative will provide policy recommendations on how best to allow retail bank customers to share their financial transaction data with fintechs and other financial services providers such as small and mid-sized banks to facilitate application development so that retail clients can compare financial products and change bank accounts more easily.

The government initiative is credit negative for the largest Canadian banks’ retail operations because it has the potential to incrementally weaken the industry’s favorable industry structure of a few concentrated players, and therefore the banks’ retail franchise strength and associated high profitability.

The largest Canadian banks are Bank of Montreal (BMO, Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Royal Bank of Canada (RBC), The Toronto-Dominion Bank (TD) and National Bank of Canada (NBC). As of 31 October 2018, these six banks held 87% of Canada’s banking assets.

Canada’s banking system is highly concentrated and more profitable for the largest incumbents than in other banking jurisdictions.

Moody’s says “we believe the six largest banks have sufficient financial resources and fintech expertise to adapt to innovation in consumer banking. Nonetheless, technological disruption is likely to erode the incumbents’ profitability in certain retail lending products, such as credit
cards, and/or payments over the long term as smaller, more agile banks achieve competitive advantages”.

Comparing Notes: Canadian And Australian Property

I talk property and finance with Daniel from Formafist, who covers the Canadian property sector.

See the second half of the discussion when we turn to the Australian property market over at his site.

Part 2:

Canada’s housing prices just stalled for the first time outside of a recession

From Business Insider.

Canadian real estate prices are acting a little skittish. The Teranet–National Bank House Price Index, shows real estate prices stalled across the country. In addition, the index is making moves we haven’t seen outside of a recession.

Tera-What?

If you’re a regular reader, feel free to skip this. For those that don’t know, The Teranet-National Bank HPI is a different measure of real estate data, that relies on property registry information instead of sales. Many misinformed agents refer to this as a “delayed” measure, but that’s not the case. The use of registry data means that the information is “late” compared to the MLS, but it’s more accurate.

Using registry information means only completed sales are included. In contrast, the MLS uses just sales. In a hot market, few sales fall through, so the MLS is definitely a faster read. In a cooling market, sales can start to fall through, as some buyers look for a way out while prices drop. This is often not reflected in MLS data, since a transfer occurs 30 to 90 days after a sale. They each have their trade offs, and neither is better or worse than they other. If you’re really into housing data, it’s best to check both to get a real feel for the market.

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Canadian Real Estate Prices Are Unchanged

Canadian real estate prices didn’t do a whole lot in March. The 11 City Composite index remained virtually unchanged compared to February. Prices are up 6.61% compared to the year before. National Bank analysts noted this is “the first time outside a recession when the March composite index was not up at least 0.2%” It was also the first time that only 4 out of the 11 markets saw an increase, outside of a recession. The unusual move is definitely worth noting from a macro perspective.

Toronto Real Estate Prices Are Flat

The Toronto real estate market has no idea what to do right now. The index showed prices remained flat from last month, and up 4.31% from last year. Prices are down 7.3% from the July peak when adjusted, and 7.9% when non-adjusted. This is the lowest pace of annual price growth since November 2013.

Funny thing to note is experts, including some bank executives, are saying the correction is over. Technically speaking, a correction hasn’t even begun according to this index. A correction is when prices fall more than 10% from peak, in less than a year, which we haven’t seen yet. If I didn’t know any better, it would appear that ~~mortgage sellers~~ bank executives are misinformed. How strange.

Vancouver Real Estate Prices Hit A New All-Time High

Vancouver real estate prices, driven entirely by condo appreciation, hit a new all-time high. Prices increased 0.5% from the month before, and are up 15.43% from the same month last year. Prices on the index showed monthly increases in 13 of the past 15 months. Teranet-National Bank analysts noted that gains are tapering, and this is “consistent with the Real Estate Board of Greater Vancouver.”

Montreal Real Estate Prices Drop 0.2%

The market brokerages have been attempting to rocket, appears to be a failure to launch. The index showed that prices declined 0.2% in March, and are up just 4.27% from the same month last year. Annual price increases peaked in December at just under 6%, and has been tapering ever since. Technically speaking, Montreal has yet to outperform the general Canadian market. Despite what you may have read in Montreal media.

Canadian real estate prices are acting unusual compared to movements typically made outside of a recession. However, they are moving in a typical real estate cycle. A gain as large as we’ve seen nationally, has never not been followed by a negative price movement. Try to act surprised when you see it. Bank economists will.

Canada Reinforces Mortgage Underwriting Guidelines

From Moody’s.

On Tuesday, Canada’s Office of the Superintendent of Financial Institutions (OSFI) published the final version of “Guideline B-20 − Residential Mortgage Underwriting Practices and Procedures,” which mandates more stringent stress-testing for uninsured mortgages. The guideline, which takes effect on 1 January 2018 and applies to all federally regulated financial institutions in the country, is credit positive because it will improve asset quality for Canadian banks.

The guideline sets a new minimum qualifying rate, or stress test, for uninsured mortgages at the higher of the five-year benchmark rate published by the Bank of Canada, the central bank, or the contractual mortgage rate plus 2%. Lenders also will be required to impose and continuously update more effective loan-to-value (LTV) limits and measurements.

A key vulnerability of Canadian banks is the high and rising level of private-sector debt/GDP. Canadian mortgage debt outstanding has more than doubled in the past 10 years (see Exhibit 1) and the index of house prices to disposable income has increased 25% over this period (see Exhibit 2), raising the prospect that real estate overvaluation is driving up overall household debt and overextending borrowers.

OFSI’s action is the latest in a series of macro-prudential measures aimed at slowing house-price appreciation in Canada and moderating the availability of mortgage financing. These measures will address the increasing risk that that growing private-sector debt will weaken Canadian banks’ asset quality. Canada’s growing consumer debt and elevated housing prices threaten to make consumers and Canadian banks more vulnerable to downside risks.

In addition to requiring that all uninsured mortgages be stress-tested against a potential rise in interest rates (high-ratio insured mortgages are already required to meet such tests to qualify for mandatory mortgage insurance), the guideline requires that banks establish and adhere to risk-appropriate LTV limits that keep current with market trends. Additionally, the guideline expressly prohibits banks from arranging with another lender a mortgage, or a combination of a mortgage and other lending products (known as bundled mortgages), in any form that circumvents a bank’s maximum LTV ratio.

Housing prices are at record highs owing to price increases in the urban areas of Toronto, Ontario, and Vancouver, British Columbia. Macro-prudential initiatives dampened volumes and prices in Toronto over the summer, but the effects of similar moves in Vancouver last year appear to be lessening this year as prices regain momentum. We believe that high consumer leverage could result in future asset-quality deterioration in an economic downturn or a housing price correction. Although Canadian banks have demonstrated prudent underwriting standards in the past, this is attributable in part to thoughtful regulatory oversight.

The new guideline follows a consultation period that ended in August. Some industry participants recommended a delay in implementation, cautioning that the combined effect of multiple macro-prudential measures affecting the mortgage market risked unduly depressing the housing market, thereby triggering a severe price correction.

Risk Mounts for Canada Housing, but Don’t Expect U.S. Crisis Redux

Unsustainable home prices and record high household leverage render the Toronto and Vancouver housing markets increasingly vulnerable to a steep price correction, though key structural features will safeguard Canada from repeating the U.S. housing crisis, according to Fitch Ratings in a new report.

Home prices in Toronto and Vancouver are up 45% and 36%, respectively, since January 2015 through May of this year. Additionally, household debt to disposable income remains elevated at 167% in 1Q17, the highest amongst G7 sovereigns.

Mortgage-market reforms are also increasing the focus on a private label RMBS market in Canada. This will inevitably draw comparisons by some in the market to the U.S. RMBS market and the influential role it played in the U.S. housing crisis a decade ago. “However, Canada is unlikely to mirror the declines and fallout experienced during the U.S. housing crisis due to major differences in the housing and mortgage finance systems,” said Fitch Director Kate Lin.

“Canadian banks are subject to rigorous oversight and regulations requiring prudent mortgage lending and underwriting standards,” added Lin. “What’s more, credit quality for Canadian mortgage loans remains strong unlike the drift towards weak borrower and loan quality that we saw a decade ago in the U.S.” Further, nonprime credit quality originations in Canada are low, making up approximately 10% of volume compared to 50% in the U.S. during the peak. The Canadian government has also been proactive in managing the risk of the nation’s housing market by taking unprecedented steps to tighten credit and limit speculation.

Housing Risks Escalate for Canadian Banks

Home prices continue to hit new highs which could cause challenges for Canadian banks if there is a severe economic shock, according to Fitch Ratings‘ latest North American FI Chart of the Month. Banks with more mortgage exposure to greater Toronto and Vancouver may be more sensitive to any rapid market correction in these two markets.

“Home price growth in Toronto and Vancouver is outpacing fundamentals however most Canadian banks should be able to withstand a market correction, but in the event of an adverse unemployment shock or rapid rise in interest rates, banks could be more heavily impacted,” said Doriana Gamboa, senior director, Fitch Ratings.

In the event of a severe economic shock, Fitch expects that Canadian Mortgage and Housing Corporation (CMHC) would act as a shock absorber for the insured mortgage exposure, which is about an average 55% of total mortgage exposure for the Big Six. Ratings could be affected in such a scenario; however, Fitch believes banks have adequate capital cushions to absorb this risk.

“Recent attempts by federal, provincial and local governments to cool the housing market through various measures, so far have not dampened prices and risks may escalate for banks, though given healthy capital levels a modest correction would be manageable,” added Gamboa.

The big six Canadian banks still dominate the housing sector and Fitch does not see this changing even with the rise of the nonbank mortgage sector. Currently, nonbank mortgage companies account for 13% of the $1.4 trillion mortgage market. With eyes on Home Capital Group (HCG), the largest alternative mortgage lender, Fitch notes that the liquidity issues are specific to its business model and current credit measures do not suggest asset quality problems.

“It’s unlikely that nonbank mortgage companies will dominate the housing sector anytime soon as the tightening of CMHC mortgage insurance rules implemented in October 2016 impacted a significant funding source for mortgage companies,” concluded Gamboa.

Canada Mortgage Rules a Step Toward Cooling Home Prices

Fitch Ratings says new Canadian Department of Finance mortgage rules to reduce speculation in residential real estate are a step toward cooling the housing market in major cities including Toronto and Vancouver. The new rules could result in improved credit quality in certain residential covered bond programs.

The rules include applying an interest rate stress test for all insured mortgages starting on October 17; previously, this was only required for homebuyers with a down payment of less than 20% of the home purchase price or for mortgages of less than five years. Tightened mortgage insurance eligibility requirements for “low-ratio” mortgages – mortgages for less than 80% of a home’s purchase price – will also be applied from Nov. 30. The government has also proposed to no longer exempt non-residents from paying capital gains taxes on income from selling a property.

Fitch believes that the new measures may temper the housing market, especially in cities that are significantly overvalued. According to a Fitch study published earlier this year, home prices across Canada are estimated to be about 25% above their sustainable value with major regional variations.

The income tax rule change in particular should reduce housing demand from foreigners. In Vancouver, this will reinforce the effects of the 15% tax on foreign home purchases put in place by the British Columbia government in August. Data from the Real Estate Board of Greater Vancouver indicate that average sale prices of detached houses have already dropped by roughly 16%, led by higher priced properties.

The new mortgage insurance guidelines could improve portfolio credit quality in the Canadian registered covered bond programs. While insured mortgage loans are prohibited from securing this subsector of the covered bond market, changes to insured mortgage loan underwriting requirements could influence non-insured mortgage loan underwriting requirements. Any tightening of non-insured mortgage loan underwriting requirements would further help to cool the housing market and also help to address the concern of heightened borrower leverage.

Canadian Banks To Hold More Mortgage Loan Risk

Moody’s says Canada’s Department of Finance announced that it will launch a consultation process with market participants this fall on lender risk sharing, a policy that would require mortgage lenders to absorb a portion of loan losses on insured mortgages that default. Currently, banks are able to transfer virtually all of the risk of insured mortgages to mortgage insurers, and indirectly to taxpayers through a government guarantee.

Any changes to the provisions of mortgage insurance to impose risk sharing on mortgage lenders would be credit negative for Canada’s six large banks, which account for approximately 72% of mortgage lending in the country, because it would reduce their asset quality and risk-adjusted profitability. The six banks are The Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and National Bank of Canada.

The details of the Department of Finance’s plan have yet to be released, and it may be some time before they emerge. Possible approaches include imposing first-loss deductibles on banks, whereby the lender would be responsible for an initial portion of the loss, with the insurer only bearing losses beyond that deductible amount. Another option would be to divide losses between the lender and insurer on a pro rata basis, or to charge the lender a fee for a defaulted mortgage. In any case, the concept of the lender retaining some risk on insured mortgages will support stability in the housing market in Canada by encouraging prudent underwriting standards.

Canadian banks’ high asset quality is largely the result of their significant holdings of government-insured residential mortgages, uninsured mortgages, securities, cash and deposits with financial institutions, which comprise about half the aggregate system’s balance sheet. Canadian mortgage portfolios and home equity lines of credit have performed well historically, owing to the high use (approximately 50%) of government backed mortgage insurance, and conservative underwriting practices. Government-supported insured mortgages make up 12% of total assets. This insurance is primarily sold either directly to the borrower, who is legally required under Canada’s Bank Act to obtain insurance if the loan-to-value of the mortgage exceeds 80%, or is held by the lenders themselves on a portfolio basis as a liquidity and capital management tool.

Canadian banks currently make a solid margin on insured mortgages for which they bear no risk and have no regulatory capital requirements. Under any risk-sharing arrangement, depending on the degree of loss shared and any offsetting concession on insurance premiums paid, profitability on a significant asset class will change. On balance, we expect that risk-adjusted profitability will decline, although a detailed analysis at this point is not possible.

Canadian LMI’s Will Need More Capital

According to Moody’s, Canada’s national banking and insurance regulator, the Office of the Superintendent of Financial Institutions (OSFI), published for comment draft guidelines on changes to capital requirements for mortgage creditor insurers.

The draft advisory provides a new standard approach for residential mortgage insurance that is more risk sensitive and incorporates new key risk and loss drivers including creditworthiness, remaining amortization, and outstanding loan balances.

These new capital requirements, if implemented as drafted, would increase overall capital for Canada’s mortgage insurance industry and Canadian Crown corporation, Canada Mortgage and Housing Corporation, a credit positive.

The draft guidelines require a supplemental capital requirement for mortgages insured in Canada’s 11 largest metropolitan areas when those cities show indications of high house prices relative to income levels, similar to bank capital requirements introduced earlier this year. This supplemental charge will create a capital cushion for mortgage insurers’ exposures in cities whose housing markets have had rapid price appreciation, such as Vancouver, British Columbia, and Toronto, Ontario. We believe required capital for mortgages in
these cities will increase.

Of the CAD1.6 trillion in outstanding Canadian mortgage debt, including home equity lines of the credit, almost half are covered by creditor insurance (see exhibit). This insurance is primarily sold either directly to the borrower, who is legally required under the Bank Act to obtain it if the mortgage’s loan-to-value ratio exceeds 80%, or lenders purchase the insurance on a portfolio basis as a liquidity and capital management tool.

The Canadian government limits its mortgage insurance guarantee to CAD900 billion, which is shared among only three entities. CMHC, which as a crown corporation with government agency status, effectively makes any policies it writes a direct contract with Canadian government. Under legislation, CMHC’s insurance-in-force is limited to CAD600 billion. The Canadian government also provides a 90% guarantee on the insurance in force of two private-sector insurers, Genworth and Canadian Guaranty Insurance Company of Canada, in the event that one of them fails. This CAD300 billion guarantee is shared between the two insurers.

These and other recent actions by Canadian policymakers will assist in slowing rapid house price appreciation and corresponding mortgage growth, reducing the prospect of a sharp housing price correction that would increase credit losses at Canadian banks. Increasingly, elevated housing prices have driven up Canadian household indebtedness, a key threat to the stability of the Canadian banking system. Since 2008, Canadian policymakers have implemented a series of changes to the rules for government-backed insurance, including limitations on amortization, premium increases and elimination of specialized product offerings.

We do not believe this has any credit implications for Canadian banks that hold insured mortgages because their exposures to mortgage insurers are already backstopped by the Canadian government.

Canadian Regulators Ups The Ante On Residential Mortgage Lending

According to Moody’s last Thursday, Canada’s Office of the Superintendent of Financial Institutions (OSFI) notified the country’s regulated mortgage lenders that it will intensify its supervisory oversight of their residential mortgage underwriting practices.

In the past 10 years home prices in Canada have lifted more than in Australia, although the debt to disposable income ratio at around 155% is still lower than Australia (175%) but higher than the UK (~130%). The Canadian market is also exposed to the impact of future interest rate rises.

Moody’s says that Canadian housing prices have risen faster than most other industrialized countries, resulting in house price levels increasing substantially over the past 10 years to be among the highest in major industrialized countries (see Exhibit 2), and raising the risk of a price correction. Over the past 25 years, house prices in Canada have steadily increased, primarily in urban centres such as Toronto, Ontario, and Vancouver, British Columbia.

The regulator vowed a heightened focus on income verification, mortgages with loan-to-value ratios of less than 65% (which OSFI indicated was a category in which underwriting practices are often less rigorous), stress assumptions related to debt-service ratios and the reliability of property appraisals. OSFI’s announcement is credit positive for Canadian banks because heightened regulatory scrutiny will force them to maintain or enhance existing residential mortgage underwriting controls and practices amid growing concerns about increasing household debt and elevated housing prices.

Residential mortgage debt, including home equity lines of credit (HELOCs), has doubled over the past decade. Canadian conventional mortgage debt, excluding home equity lines of credit (HELOCs), has grown at a compound annual rate of 7% over the past decade. Almost CAD1.6 trillion in mortgage debt, including HELOCs, was outstanding as of 31 March 2016, more than double the amount outstanding for the same period 10 years ago (see Exhibit 1).

Over the past 25 years, Canadian consumer debt-to-income levels, which include mortgage debt, almost doubled and are at a record high. As a result, housing indebtedness has tracked closely to house price increases as borrowers take larger loans, while at the same time, incomes have not kept pace. These higher debt levels make Canadian consumers vulnerable to an employment or interest rate shock that would exacerbate their debt-servicing burden (see Exhibit 3).

Of note, OSFI specifically indicated its interest in debt service ratios because current underwriting requirements may not adequately capture the stress effect of refinancing a mortgage into one with a higher mortgage interest rate. This is important because of the unique characteristic of a Canadian mortgage. A Canadian mortgage is structured as a balloon loan whereby the term (typically five years) is shorter than its amortization (typically 25 years). This means borrowers must periodically refinance their mortgages (see Exhibit 4), exposing them to changes in interest rates over the life of the mortgage. This refinancing risk is greatest for recent borrowers with high loan-to-value mortgages in a rising interest rate environment. OSFI noted that a rapidly rising interest rate environment would place considerable stress on existing debt service ratios, particularly on investment properties with rental income.