Canadian Banks Not Immune to Housing-Related Failures

Canada’s banks, ranked the soundest on the planet by the World Economic Forum, aren’t immune to collapses triggered by falling housing prices, according to the government official implementing new mortgage rules.

Previous failures of Canadian financial institutions were due to bad real estate lending and sharp falls in housing prices, and these can happen again, Vlasios Melessanakis, manager of policy development at the Office of the Superintendent of Financial Institutions, wrote in documents obtained by Bloomberg News under freedom-of-information law. The last failure in Canada was in 1996.

“Canada is not immune,” Melessanakis wrote March 21 in internal notes responding to a posting on a mortgage-industry website. “Just because nothing happened in Canada in 2008 (a U.S.-centered crisis), does not mean that Canada is not vulnerable to a housing correction now.”

The comments underscore tension between policy makers and mortgage lenders as a booming housing market helps drive profits at banks. Finance Minister Jim Flaherty has tightened mortgage rules three times and put the federal housing agency’s books under regulator oversight, while Bank of Canada Governor Mark Carney has repeatedly warned household debt is the economy’s biggest domestic risk.

Participants at Bloomberg’s Canada Economic Summit in Toronto last week, including the head of the country’s biggest bank, downplayed talk of a housing bubble even after Canadian housing starts rose to the highest since September 2007 last month.

Pockets of Vulnerability

“When we look at the overall marketplace, there might be pockets of vulnerability but we remain quite comfortable,” Gordon Nixon, chief executive officer of Royal Bank of Canada, said May 8. “Frankly, I’d like to see the rhetoric come down a little bit.”

Melessanakis wrote his comments to colleagues in response to a posting on a mortgage-industry website, Canadian Mortgage Trends, that criticized proposed standards published by Canada’s top banking regulator on March 19.

Ottawa-based OSFI suggested requiring lenders to take “reasonable steps” to verify borrower incomes, establish standards for measuring borrowers’ ability to pay their debts, and limit the size of loans secured by the equity in people’s homes. The draft guidelines are based on mortgage-lending principles set by the Financial Stability Board, a Basel-based group that coordinates global financial rules.

Unsound Fundamentals

“How many new lending ‘guidelines’ can the market bear before it breaks?” wrote Robert McLister, a mortgage planner who edits the website.

“The market may break because the fundamentals are not sound (i.e. overvaluation of homes), not because of OSFI guidance,” Melessanakis wrote in response.

A spokesman for the regulator said Melessanakis’s remarks don’t reflect the regulator’s official position. While they were shared with the agency’s communications and consultation division, they were not sent to superintendent Julie Dickson, spokesman Brock Kruger said in an e-mail.

There’s “no question” the proposed OSFI guidelines will curb demand and hurt housing prices, McLister said in an interview. “OSFI had good intentions here, but some of this policy is certainly misguided,” he said, when asked to react to Melessanakis’ comments.

Canadian existing home sales rose 0.8 percent in April from the previous month and 11.5 percent from a year earlier, the Canadian Real Estate Association said in a statement today. The average home price rose 0.9 percent from April 2011, the group said in a statement.

Strongest Banks

Melessanakis referred a request for comment to OSFI’s communications staff.

Four Canadian banks were among the world’s six strongest in Bloomberg’s second annual rankings. Canadian Imperial Bank of Commerce was No. 3, followed by Toronto-Dominion Bank (No. 4), National Bank of Canada (No. 5) and Royal Bank (No. 6).

Lenders have been increasingly skeptical of the need for new rules to cool the housing market. The government should hit the “pause” button and take stock of regulations introduced since the financial crisis, Terry Campbell, president of the Canadian Bankers Association, said in an April 3 speech.

In January last year, Flaherty reduced the amortization period on mortgages backed by the government to 30 years from 35, the third time since 2008 he has tightened rules for home loans.

Strengthening Oversight

Flaherty introduced legislation April 26 that includes measures to strengthen oversight of Canada Mortgage & Housing Corp., a government-owned mortgage insurer. The law allows OSFI to review CMHC’s books at least once a year, and prohibits banks from using insured mortgages to back covered bonds, which lenders have been issuing to fund their home-lending business.

OSFI’s Dickson said in a May 9 speech that Canadian banks should not be “lulled into a false sense of security” by steps policy makers are taking to prevent another financial crisis.

McLister pointed to banks’ low arrears rates on mortgages as evidence more rules aren’t needed. Melessanakis wasn’t convinced.

“This can change fast,” he wrote in his notes. “Are the banks equipped to handle a 40 percent drop (what occurred in Toronto market in early 1990’s)? Need to stress test to find out.”

McLister called the idea of a 40 percent decline in housing prices across the country “farcical.” Such a decline is “not going to happen, period. But in some places like Vancouver, maybe Toronto, obviously you’re going to have greater risk there of price volatility,” he said by telephone.


OSFI’s guidelines suggest lenders limit home-equity lines of credit to 65 percent of the property’s value. The regulator also recommends that HELOCs be paid off over a specific amortization period, like conventional mortgages.

While McLister wrote that those rules “portend a big slowdown in HELOCs,” Melessanakis responded that the loans have “contributed significantly to growing overall household debt.”

“This is not sustainable,” he wrote. “If (or when) housing prices drop, households will be vulnerable,” echoing comments made by Flaherty and Carney.

Melessanakis also disputed McLister’s point that many of OSFI’s recommendations are already employed by “scores of lenders.” “Not all, and not on a consistent basis,” the OSFI official said. “There are some enhancements in lending practices that are needed.”

Last Failure

Melessanakis doesn’t name specific lenders in his comments. OSFI regulates 151 deposit-taking institutions, including 77 banks as well as trusts, loan companies and credit unions.

The last financial institution failure in Canada occurred in 1996, when Security Home Mortgage Corp. collapsed, according to the Canada Deposit Insurance Corp., a government agency that insures deposits. Security Home Mortgage had assets of C$65 million ($64.8 million) the year before it failed.

Eighteen financial institutions failed in the 1990s, including Confederation Life Insurance Co., which had C$19.2 billion in assets at the end of 1993. There were 23 failures in the 1980s, including Northland Bank, which had C$1 billion in assets.