Wind-down in government stimulus support expected to result in uptick in mortgage delinquencies

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Canada’s big banks have become more vulnerable to losses from economic shocks after increasing exposure to red-hot real estates markets in Vancouver and Toronto at a time when the level of government-backed residential mortgage default insurance was declining, according to a new report from Moody’s Investors Service.

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Another contributing factor is the winding down of COVID-19 government support programs such as the Canada Recovery Benefit, which have been keeping households solvent and helping to maintain high overall credit quality, the ratings agency said in the report to be widely released on Wednesday.

“Our view is that there will be an uptick in residential mortgage delinquency once all support measures are exhausted,” said the report’s author Jason Mercer. “Mortgage losses will likely rise as stimulus wanes.”

The ratings agency noted that the supports including income supplements put in place to offset the economic impact of COVID-19 pandemic restrictions are disappearing at a time when fewer residential mortgages are insured.

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Mortgage losses will likely rise as stimulus wanes

Jason Mercer

Insured residential mortgages made up just 26 per cent of mortgage exposures at the banks at the end of the second quarter of 2021, down from 47 per cent five years ago.

This is a result of the Canada Mortgage and Housing Corporation (CMHC) reducing the availability of portfolio insurance for the largest banks in an effort to lower the government’s exposure to the housing market, Mercer said.

In addition, both national and provincial policymakers have taken steps to slow the rate of mortgage lending growth in Canada by tightening underwriting standards and reducing the availability of insurance banks can purchase for pools of mortgages.

At the same time, the report notes, provinces that contain the country’s hottest residential real estate markets where home prices rose even during the pandemic — Toronto and Vancouver — account for a larger proportion of total mortgage lending than they did five years ago.

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Ontario now represents 45 per cent of total mortgage lending, up from 41 per cent in 2016. British Columbia accounts for 20 per cent, up from 17.

Despite these factors, Moody’s said the country’s largest lenders are not expected to be battered because they have been generating strong earnings and have “prudently” made provisions for loan losses in their portfolios.

“In addition, their capital levels to absorb unexpected losses are higher than in our previous stresses,” the report said.

The Office of the Superintendent of Financial Institutions (OSFI) required Canadian banks to keep a larger capital cushion on hand during the COVID-19 pandemic.

Despite an expectation of of increased losses in times of stress — with aggregate Tier 1 common equity deterioration of 76 basis points compared to 61 in 2018 and 56 in 2016 — all eight of the large mortgage lenders assessed by Moody’s had higher “ending” capital ratios than they did in earlier cycles.

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“Capital ratios at these lenders are historically high, so their post-stress capitalization is better than in previous stresses,” said Mercer, the report’s author.

“And the banks have all taken provisions for losses in their earnings since the crisis began. As such, we believe there will be a minimal, if any, impact on banks’ earnings.”

Moody’s looked at the five largest banks in Canada: Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, and Canadian Imperial Bank of Commerce. The analysis also included National Bank of Canada, Fédération des caisses Desjardins du Québec, and HSBC Bank Canada.

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In earlier analyses, Moody’s has considered the possibility that mortgage defaults could have have a wide-ranging impact on the housing market and home prices. But Mercer said the current analysis suggests other factors would offset any serious impact.

“While we believe there will be a modest increase in residential mortgage delinquency, the economic recovery will support sales activity in the housing market,” he said.

“We don’t believe there will be a sufficient number of foreclosures to negatively affect house prices.”

Financial Post

• Email: bshecter@nationalpost.com | Twitter:

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