Aggressive and Rapid Interest Rate Hikes Increase Canadian Residential Mortgage Risks
With the Bank of Canada raising its benchmark interest rate by 350 basis points (bps) to 3.75% since March 2022, consumer borrowing costs have increased and, as a result, housing affordability concerns have intensified. With fixed-rate mortgage borrowing costs notably increasing during 2021 and into 2022, the resulting spread between variable- and fixed-rate mortgages has led to a surge in variable-rate mortgages and longer amortizations. Both of these trends expose borrowers to interest rate risk in the current environment where bank prime lending rates increased to 5.95% from 2.45% in just a seven-month time span. The high level of household indebtedness and elevated house prices remain two of the key vulnerabilities in the Canadian financial system.Key highlights include the following:
-- Rapid and aggressive interest rate hikes are increasing the debt service burden and, as a result, have intensified housing affordability concerns and vulnerabilities.
-- A surge into variable-rate mortgages and longer amortizations have increased highly indebted consumers' exposure to interest rate risk. Although the majority of variable-rate mortgages have fixed payments, higher interest rates will generally result in material increases to borrowers' mortgage payments at renewal.
-- A Bank of Canada severe stress testing scenario indicates the large Canadian banks remain resilient but the financial impact and losses to the Big Six would be substantial, with CET1 levels reducing by approximately 400 bps. Estimated credit loss rates would be 4.4% (total) and 0.7% (uninsured mortgages).
“Aggressive and rapid interest rate hikes are increasing borrowing costs to service debt. At the same time, elevated inflation levels are eroding borrowers' disposable income available to service this debt. Whether the payment shock is immediate or delayed, housing affordability concerns and vulnerabilities are increasing, particularly for highly indebted households that have been extending themselves financially to purchase homes at elevated prices. These risks, however, are partially mitigated by OSFI's minimum qualifying rate stress test on originations that provides a buffer to absorb some of the impact from recent interest rate increases, a low unemployment rate and tight labour market, and increased household net worth levels,” said Carl De Souza, Senior Vice President, North American FIG.
Bank of Montreal is a financial services organization. Co. provides a range of retail banking, wealth management and investment banking products and services. Co. serves its clients through three operating groups: Personal and Commercial Banking, which provides financial services to personal and commercial customers; Private Client Group, which provides wealth management products and services to individuals and select institutional segments; and BMO Capital Markets, which provides clients financial and capital markets services to corporate, institutional and government clients.
Scotiabank is a financial services provider in North America, Latin America, the Caribbean and Central America, and parts of Asia. Through its three operating segments: Canadian Banking, International Banking, and Global Banking and Markets, Co. provides a range of advice, products and services, including personal and commercial banking, wealth management and private banking, corporate and investment banking, and capital markets. As of Oct 31 2017, Co. had total assets of C$915,273 million and total deposits of C$625,367 million.
Canadian Imperial Bank of Commerce is a financial institution. Through its three business units, Co. provides a range of financial products and services to individual, small business, commercial, corporate and institutional clients in Canada and around the world. Co.'s Retail and Business Banking business unit provides financial advice, products and services. Co.'s Wealth Management business unit provides integrated advice and investment solutions. Co.'s Capital Markets business unit provides integrated credit and global markets products, investment banking advisory services and research. As of Oct 31 2017, Co. had total assets of C$565.26 billion and total deposits of C$439.71 billion.
National Bank of Canada is a provider of financial services that include banking and investment solutions for individuals and businesses as well as securities brokerage, insurance and wealth management services. Co. operates in three business segments: Personal and Commercial, which encompasses the banking, financing, and investing services; Wealth Management, which comprises investment solutions, trust services, banking services, lending services and other wealth management solutions; and Financial Markets, which encompasses banking services, investment banking services and financial solutions. At Oct 31 2017, Co. had total assets of C$245.83 billion and total deposits of C$156.67 billion.
Royal Bank of Canada is a financial services company that provides personal and commercial banking, wealth management services, insurance, investor services and capital markets products and services. Co. serves personal, business, public sector and institutional clients through offices in Canada, the U.S. and 37 other countries. Co. is organized into five segments: Personal and Commercial Banking, which is comprised of Co.'s personal and business banking operations, and its auto financing businesses; Wealth Management, Insurance; Investor and Treasury Services; and Capital Markets. As of Oct 31 2017, Co. had total assets of C$1.21 trillion and total deposits of C$789.64 billion.
Toronto Dominion Bank provides financial services. Co.'s segments comprised of: Canadian Retail, which include Canadian personal and commercial banking businesses, Canadian credit cards, TD Auto Finance Canada and Canadian wealth and insurance businesses; US Retail, which includes the US personal and commercial banking businesses, US credit cards, TD Auto Finance US, US wealth business and the Bank's investment its subsidiary, TD Ameritrade Holding Corporation; and Wholesale Banking, which provides a range of capital markets, investment banking, and corporate banking products and services. As of Oct 31 2017, Co. had total assets of C$1.28 trillion and total deposits of C$832.82 billion.
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