Bank of Canada's record tightening campaign exposes lenders' mortgage risks (updated)

RBC Bearings

13/07/2023 17:19

(Updates with comments in paragraph 13)
    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, struggling to make higher payments or pay even
the interest portion of their home loans, investors and analysts
said.
    After urging lenders to tackle 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 insufficient to cover the
interest component of home loans. The excess amount gets added
to the outstanding loan, 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 must 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, 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 a record low and more than half of home buyers took out
floating rate loans. Analysts estimate some C$331 billion ($251
billion) in mortgages come up for renewal in 2024 and C$352 the
following year, illustrating the enormity of refinancing
challenge.
    Consumers are largely able to make their payments for now,
thanks to strong employment. Also, consumers getting mortgages
have been stress-tested for higher rates than their original
mortgage.  
    
    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
extensions, 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 warned the two banks
risk losing mortgage market share due as their products offer
less flexibility.
    RBC and Scotiabank said it has been working with customers
individually and reaching out to customers proactively in the
current rising rate environment. National Bank did not offer a
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.
    Canada's banking regulator's latest proposal to increase
capital requirements puts "modest" challenges 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
and David Gregorio)
 ((Nivedita.Balu@thomsonreuters.com; Twitter: @niveditabalu;))