While the Canadian housing market may be roaring, two resourceful RBC Capital Market analysts pored through the numbers to determine Canadian banks’ exposure to mortgage debt, and concluded that while the industry would be able to weather the storm, these were some of their biggest concerns:
“We believe 10% to 20% of mortgages under deferral are at a higher risk of defaulting. We are most concerned about borrowers on a deferral program who are unemployed (and were receiving the Canada Emergency Response Benefit, or CERB) and borrowers on a deferral program who are employed but are earning less than what they earned pre-COVID,” wrote RBC analyst Darko Mihelic and senior associate Sanly Li in a report earlier this week.
“We are also concerned about borrowers not on a deferral program but are facing some form of financial hardship. If 20 per cent of mortgages under deferral eventually become delinquent in Canada, this equates to a mortgage delinquency rate of 2.3 per cent which is almost 4 times higher than the peak Canadian mortgage delinquency rate over the past 30 years; however, we have reasons to be optimistic that this high level of default will not occur.”
Currently 11 per cent of mortgage borrowers from large Canadian banks — representing around $175 billion of mortgage debt — are not making payments, according to RBC.
Still, government support and a newly-acquired Canadian habit of saving money should ensure that these possible defaults never see the light of day; the RBC analysts said they “feel better” after doing a deep dive into the state of the country’s banking sector.
The revamped Employment Insurance program and other government benefits for businesses should also ensure the economy keeps ticking over and most Canadians are not immediately in danger of losing their homes.
However, the default problem could resurface after another six months when the benefits go away, making impairments a discussion point for banks in the second or third quarter of 2021.
But the analysts believe the banks can handle it.
“When thinking of reserves in total, it is important to also remember that bank reserves were originally calibrated to worse economic conditions with lower expectations of help from the Canadian government,” the analysts wrote. “There are many signs that suggest the current environment is far better than last quarter.”
Canadians are also behaving responsible during the pandemic and had reduced their credit card balances by around $87.1 billion by the end of the third quarter, while their household savings rate had jumped to 28 per cent by the second quarter of 2020, versus a mere three per cent during the same period last year.
RBC estimates each applicant of the Canada Emergency Response Benefit has received $8,981 of benefits on average, giving them some fiscal cushion to ensure they keep making mortgages payments.
“We believe during the deferral period borrowers likely have saved up 4 to 6 months of mortgage payments,” the analysts stated. “We calculate the average size of a deferred mortgage to be $293,000 using the number of mortgage deferrals and the total deferred balance in Canada for the large Canadian banks. If we assumed an interest rate of 2.95 per cent (based on the average 5-year fixed rate over the past five years) and a 25-year amortization period, we calculate an average mortgage payment of approximately $1,400 per month.”
Another positive data point is the falling number of insolvencies (bankruptcies and proposals), suggesting that Canadians are not throwing in the towel just yet.
Insolvencies fell 42.4 per cent in August 2020 compared to August 2019, according to the Office of the Superintendent of Bankruptcy Canada. Consumer insolvencies fell by 42.7 per cent, while business insolvencies decreased by 25.5 per cent during the period.
The job numbers out today could also help alleviate concerns about Canadians’ debt levels. The country gained 378,200 jobs, against an expectation of around 156,600 jobs, and lowering the jobless rate to 9 per cent.