Thursday, December 1, 2011

Thurs Post #2: Concern over Canadian bank exposure to overleveraged consumers

One refrain you have heard constantly during the inflating of our housing bubble in Canada is that 'Canada is different... Canadian banks did not lend money to those who couldn't pay it back.'

That, as this blog as insisted over and over again, is a crock.

Our banks permit liar loans - loans where a self-employed person can 'declare' their annual income to qualify for a mortgage.

Our banks offer cash back for mortgages (as much as 7%) which effectively means we have zero down mortgages. You can take out a mortgage, receive 7% back (which covers the 5% down payment) and this allows you to be PAID to buy a house.

And most significantly, CMHC is absorbing all lender risk.

Take away CMHC and there is no way twenty-something couples would qualify for a 5% down mortgage at the same rate as people with money.  Without access to this easy credit, the housing bubble would collapse.

As these measures have pushed up home values, Canadians have pigged out on an orgy of debt from HELOC's and credit cards fueled by the value of their houses.

Now, according to a report by Moody’s Investors Service, concerns are being raised about Canadian bank exposure to overleveraged consumers.

Observers are asking a question that would have been almost unthinkable a year ago: Would the big banks take a hit if the debt crisis spread here and consumer defaults spiked?

The biggest single asset on Canadian bank balance sheets is residential mortgages, more than 30% of which are insured by the Canada Mortgage and Housing Corp., essentially shifting the risk of default onto the shoulders of the government.

But banks also hold substantial uninsured assets such as credit card debt, and that leaves them vulnerable.

According to David Beattie, Moody’s analyst and author of the report, the Royal Bank of Canada is the most susceptible with 24% of its total managed assets made up of uninsured loans. Next is Bank of Nova Scotia at 21%, CIBC at 20%, Toronto-Dominion Bank and National Bank of Canada both at 18%, with Bank of Montreal the most protected at 14%.

“Canadian household debt as a share of personal disposable income stood at a record 150.8% at the end of June this year.” said Mr. Beattie. “We are concerned that, while taking advantage of low interest rates, consumers are also taking on debt the may not be able to service when rates inevitably go up.”

We haven't begun our downturn yet. And people have no idea how closely tied Canadian mortgage debt and consumer debt is.

As the Financial Post notes, the European debt crisis is already having a negative impact on the global economy.

The fear is that a significant rise in unemployment could leave many households unable to meet their obligations despite the record low interest rates.

Analysts are uncertain how Canadians would react in such a situation, whether they would stop paying their mortgages — as many Americans did when U.S. economy collapsed three years ago — or whether it would be credit card debt or auto loans that would take the hit.

Another area of uncertainty is the makeup of the banks’ consumer loan portfolios. There is limited detailed information on the various categories of loans, making it difficult to guage Canadian banks’ true exposure.

Certainly this blog suspects that if real estate turns in Canada, the resulting fallout will be catastrophic.

Perhaps that's when the ruling federal Conservative government in Canada moved heaven and earth to protect the real estate industry when the US market started going under in 2006.

We've had the zero down, forty year mortgage. The ability to raid the RRSP fund for down payments. The Home Reno Tax Credit. Emergency interest rates. First-time buyer’s closing cost credit. Regulations that permit liar loans. Regulations that permit zero-down payments with cash back from mortgage lenders. And CMHC increasing loan value on their books from just over $100 million to well over $700 million while assuming all lender risk.

Cheap credit, artificially supressed interest rates and government policy have attempted to fuel and protect the real estate boom in the hopes the Great Global Recession would pass before the impacts him home in the Land of the Maple Leaf.

In short our government gambled... much like the Trudeau government gambled on oil in the 1970s.

If it blows up... it is going to be really, really ugly.


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