Canada Banks, Mortgage Insurers Can Weather Shock: Moody’s

Updated on
  • Moody’s sees C$18 billion system losses in U.S.-style crisis
  • RBC would have highest losses, while CIBC capital hit hardest

Canada’s big lenders and mortgage insurers would be able to absorb an estimated C$17.6 billion ($13.7 billion) in losses from a U.S.-style housing shock, due to government guarantees for home loans, lower subprime lending and less repackaging of mortgages for investments, Moody’s Investors Service said Monday in a report.

Royal Bank of Canada would face the biggest hit, with C$2.87 billion of losses, followed by Toronto-Dominion Bank with C$2.64 billion, according to stress tests by the New York-based ratings company. Canadian Imperial Bank of Commerce, which has the largest relative exposure to domestic mortgages, would have the biggest drop in regulatory capital among the seven largest lenders tested, with its Common Equity Tier 1 ratio dropping by 120 basis points, Moody’s said in the report Monday.

“Even if we looked at a severe housing correction similar to that of the U.S., which is many orders of magnitude greater than what we’ve ever seen in Canada historically, the Canadian banks would still be able to weather the storm with losses totaling just a few quarters of earnings at most," Jason Mercer, assistant vice president with Moody’s, said in an interview. "The Canadian bank system would not be at risk from some sort of severe housing crisis that was similar to what the U.S. had."

Second Order

Benchmark Canadian home prices rose 12.5 percent in May, the most in nine years, with Vancouver and Toronto particularly hot. Canada’s six-biggest banks and Desjardins Group, the Quebec-based credit-union group, account for three-quarters of Canada’s mortgage market, according to the report.

Moody’s simulation assumed a housing-price drop of 25 percent, with additional declines in Ontario and British Columbia. Losses would be split two-thirds between the banks and the mortgage-insurance system. The capital levels of the banks wouldn’t fall below regulatory requirements and most banks would be able to absorb losses within one quarter of earnings, Moody’s said.

Although Canadian lenders would be shielded from the worst effects of a housing shock in Canada, they wouldn’t be immune to losses due to other factors, according to Moody’s. Rising interest rates would lead to increased debt-servicing payments at renewal at a time when Canadian consumers are carrying record levels of debt. Job losses would cut borrowers’ ability to service debt. Both could lead to an increase in mortgage delinquencies, Moody’s said.

"It’s the second order and third order effects that you have to think about," Richard Nesbitt, Chief Executive Officer of the Toronto-based research firm Global Risk Institute, said Monday in an interview. "Just the housing itself I don’t think is an issue for the Canadian banks, but I do think the slowing of the economy that results from that would mean a substantial adjustment for public policy and all financial institutions."

Canadian banks are well capitalized and most of their mortgages are insured by the federal government, so any first order impacts of a U.S.-style housing collapse just “does not exist at the banks," Nesbitt said.