Editors’ pickReal Estate

Betting against Canada?

With rising rates and the impending housing crisis in the Canadian market, a systemic weakness has been singled out in the Canadian Financial system occurring within the balance sheet of Canada’s top 5 banks due to something familiarly called ‘residential mortgage loans’. All these making a case against shorting (betting against) the pillars of the Canadian banking system.

Fundamentals

The dynamic changing global macro environment

In Canada, household credit availability has skyrocketed past unprecedented levels due to the low-interest-rate environment occurring due to the events of 2008. As a result, the easy access to home loans and credit flooded the average Canadian consumer with a lot of debt. It is estimated that for the average Canadian, 70% of income earned is put towards servicing interest payments on credit card debt as well as mortgage loans. With central banks hiking interest rates as well as the daunting global macro environment which could possibly lead to higher unemployment rates, how long unto the unexplainable unfolds?

The Big bank’s Balance sheet( we’ve seen this before?)

Several Canadian banks over the past few years have amassed larger and larger residential mortgage portfolios. Royal Bank of Canada (RBC) has a residential mortgage portfolio of over $231bn, with only provisions for C$33M of credit losses — this spells danger. Bank of Nova Scotia similarly has about $208bn, Canadian Imperial Bank of Commerce (CIBC), one of Canada’s largest aggressive mortgage lenders has a $201bn exposure — with about 14% of those accruing from the greater Vancouver area. Despite all these, Bank of Montreal (BMO) totals the lowest with a figure of about $117bn. Policy-wise, it is drafted that most of these loans are guaranteed by the CMHS (Canadian Mortgage and Housing Corporation), so in the ‘expected’ event of a downturn, it is alleged that these losses are expected to be covered by the state. While this might be partly true, the other side of the coin needs to be considered.

Misunderstood Insurance agreement

Policies in Canada state that any lender that pays less than 20% of the value of a home less than $1M has to buy insurance against a default, which is backed by the state-owned Canadian Mortgage and Housing Corporation. This flatters majority of the big bank’s balance sheet, but one thing should be noted here. The uninsured segment of the market is still growing drastically due to the fact that borrowers can easily convert insured loans to un-insured through refinancings after purchasing property and waiting of price appreciations (average price of real estate in Canada (Vancouver) has skyrocketed). Uninsured buyers have also increased from over60% to 70% of new loans approved at ‘regulated’ banks. In Vancouver, the average price of a condo hit the $1M price tag, with 90% of new mortgages issued in the city being uninsured.

Recently, a small hedge fund based in the U.S placed a significant bet against all of the big Canadian Banks as their thesis points to instability in the Canadian financial system (Einhorn nostalgia?). Despite what we all may think, it remains clearly obvious that in the downturn the debt load of the average Canadian will eventually prove a tough burden to carry.

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