John Greenwood
Financial Post Mar 9, 2012
After a string of warnings from policymakers about the perilous state of household debt in this country, it hardly seemed like a good idea.
But this week the big banks launched the latest round in the mortgage war, with Bank of Montreal rolling out its rock-bottom 2.99% five-year home loan, one of the lowest rates on such a product. BMO’s peers quickly followed suit, breathlessly unveiling their cut-price mortgages, available for a limited time.
In public comments the banks wrapped themselves in the maple leaf, claiming the special rates are aimed at bolstering the finances of consumers, since the new products come with fixed rates and shorter amortizations designed to allow borrowers to pay down debt faster. “We think this is totally consistent with the debate about stability of [household finances],” said Frank Techar, head of BMO’s domestic retail bank.
“Canadians have identified effective debt management as their primary focus this year, and these special offers will help new homebuyers and existing mortgage holders reduce interest costs and pay down their mortgage sooner,” said Colette Delaney, executive vice-president at Canadian Imperial Bank of Commerce’s retail bank.
But here’s the thing. Canadian household debt has been steadily rising for more than a decade and it’s now sitting about same the level it was in the United States just before the housing collapse, precursor to one of the biggest waves of consumer defaults since the Depression.
Thanks to low interest rates and a stable economy, Canadians are managing their burden. But Bank of Canada Governor Mark Carney has warned repeatedly that elevated borrowing is the biggest domestic threat to health of the financial system.
But don’t “special offer” mortgage deals encourage people to borrow more, and doesn’t that exacerbate the problem?
Or maybe problem is the wrong word, because from the banks’ perspective it’s not so much a problem as a potential earnings headwind, according Peter Routledge, an analyst at National Bank Financial.
.Residential mortgages are hugely important for the banks, a key business in domestic retail lending which is traditionally one of the most important earnings drivers. At a time of heightened competition, profit margins are razor thin but players are making up for that by hiking the volume of loans they write.
Canadians have about $1.1-trillion of mortgages outstanding, by far the lion’s share of total consumer debt, according to the Bank of Canada.
But the bank’s are mostly protected from risk of default through insurance provided by the Canada Mortgage and Housing Corp.
On average, at least 50% of mortgages held by the banks are covered by insurance, all but the safest, low ratio loans to highly credit-worthy customers.
So in a worst-case scenario — a collapse in the housing market — the banks would have minimal direct exposure to loan losses.
But they would experience a drop in profits since a housing correction would almost certainly result in a consumer pull-back in loan demand, not just for mortgages but across the board, and the banks are very cognizant of that.
“I think banks recognize that scenario would be very bad for earnings, and why would they want to hurt their franchise?” said Mr. Routledge.
When the U.S. market started to turn, lenders responded by bringing out ever more risky products that enabled people to lever up even more because their role in the economy had become distorted.
“But that’s very unlikely to happen here because of the [more healthy] structure of the mortgage market,” he said.
Another reason for Canadian banks to be cautious is that CMHC has been fundamental not just to their business models but also to their funding. Last year the big six issued more than $25-billion of covered bonds, mostly backed by CMHC insured mortgages. Thanks to the CMHC, the interest rate on the bonds is only marginally above Canadian government bonds, and significantly lower than the funding costs of even the strongest foreign banks.
The last thing the banks want to do is anything that might cause the federal government to change the rules around CMHC insurance.
With this in mind, we can ask the question again: Are the banks increasing risk in the system with their special low-rate mortgage offers?
Bank officials suggest the main target is customers of other banks along with new customers with solid jobs and a genuine need to own homes.
Rob Mclister, editor of industry newsletter Canadian Mortgage Trends, says such offers typically result in only a small amount of business from new borrowers. Instead what they do is raise the level of market interest in mortgages and home buying generally, he said.
Not surprisingly, the banks continue to grow home loan volumes at mid single digits, a healthy clip given the weak economy.
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