Bank of Canada's record tightening campaign exposes lenders' mortgage risks
13/07/2023 11:00
By Nivedita Balu
TORONTO, July 13 (Reuters) - The Bank of Canada's
interest rate hike on Wednesday and prospects of more increases
heighten risks to mortgage lenders as homeowners are likely stay
in debt longer as they struggle to make higher payments or pay
even the interest portion of their home loans, investors and
analysts say.
After urging lenders to tackle the risks from a sharp rise
in borrowing costs, Canada's main banking regulator, Office of
the Superintendent of Financial Institutions (OSFI), on Tuesday
proposed tougher capital rules for lenders to prevent consumers
from defaulting or entering negative amortization.
Negative amortization occurs when variable home loan
customers' monthly repayments are not enough to cover the
interest component of home loans. Which means the excess amount
gets added to the outstanding loan, thereby lengthening the
repayment period.
"All of that is a realization that there is stress in the
system," said Greg Taylor, Chief Investment Officer of Purpose
Investments.
"There's definitely more risk because anytime you hike you
never know when it's going to be the straw that breaks the
camel's back."
Unlike the U.S., where home buyers can snag a 30-year
mortgage, Canadian borrowers have to renew their mortgages every
five years at the prevailing interest rates.
On Wednesday, the central bank pushed back its expectations
for getting inflation to its 2% target by six months to
mid-2025, in a sign interest rates are likely to stay higher for
longer.
The cost of a floating rate mortgage has now increased by
about 70% from the loans since October 2021, when interest rates
hit at a record low, prompting more than half of home buyers
took out floating rate loans. Analysts estimate some C$331
billion ($251 billion) in mortgages coming up for renewal in
2024 and C$352 the following year, which underscores the
enormity of refinancing challenge.
To be sure, thanks to the strong employment and being stress
tested at a higher rate, consumers are largely able to make
their payments for now.
MORTGAGE DELINQUENCIES LOW
Latest data released during the quarterly earnings showed
mortgage delinquencies for all banks were low.
Of the big six banks in Canada, Bank of Nova Scotia BNS.TO
and National Bank of Canada NA.TO do not offer mortgage
extension, meaning the payment owed by the consumer goes up for
each hike the BoC announces.
The two banks will be key for any early signs of stress as
borrowing costs rise further. Analysts also warn the two banks
risk losing mortgage market share due as their products offer
less flexibility.
Scotiabank said it has been working with customers
individually in the current rising rate environment. National
Bank did not offer an immediate comment.
Bank of Montreal BMO.TO , CIBC CM.TO and TD Bank TD.TO
each allow for negative amortization as rates rise.
More than three-quarters of people with variable-rate
mortgages had already hit their trigger rate, according to
Desjardins.
Royal Bank of Canada RY.TO , the country's biggest bank,
does not offer negative amortization but its variable rate
mortgage customers have already seen an increase in payments by
as much as 40% to cover higher interest rates, KBW analyst Mike
Rizvanovic said. While the other three banks have fully
insulated their borrowers until the mortgage is renewed.
RBC did not offer an immediate comment.
Canada's banking regulator's latest proposal to increase
capital requirements puts the most stress on CIBC depending on
how much of the portfolio ultimately moves to a negative
amortization, Rizvanovic said, adding that BMO and TD would face
"a very manageable impact."
CIBC did not offer an immediate comment.
Darcy Briggs, portfolio manager at Franklin Templeton
Canada, said one of the key factors for "keeping persistent
demand is mortgage forbearance."
"If your monthly payment doesn't change, consumer behavior
doesn't change so spending habits and patterns don't change. So
it is working counter to what the Bank of Canada is trying to
accomplish," Briggs added.
($1 = 1.3181 Canadian dollars)
(Reporting by Nivedita Balu in Toronto; Editing by Josie Kao)
((Nivedita.Balu@thomsonreuters.com; Twitter: @niveditabalu;))