This article was written for CMP by Mika Pangilinan on Mar 21st, 2024.

With credit growth grinding to a near halt and delinquency rates on the rise, it’s clear that Canadian borrowers are feeling the pinch of high interest rates and a slowing economy.

Yet, CIBC Deputy Chief Economist Ben Tal sees some silver linings amidst these challenges, which he says suggest we’re heading for more of a spending freeze rather than a large credit risk event.

First, let’s look at some of the concerning trends taking place in Canada’s credit market right now.

At the forefront is the dramatic slowdown in credit growth to levels not seen since the double-dip recession of the 1980s.

This slowdown is particularly pronounced in the mortgage sector, where the sensitivity to rate hikes has led to a dramatic decrease in new lending activity to what Tal says are recessionary levels.

“The speedy and aggressive slowing in the pace of credit growth reflects both supply and demand forces,” he writes, pointing to Bank of Canada data showing a tightening of credit availability compared to during the pandemic. “The year-over-year growth rate in credit limits available to households is now rising by half the pace seen in mid-2022 and below the pre-pandemic rate. In real terms, limits are hardly growing.”

Households are also more reluctant to use that available credit, Tal adds, with utilization rates falling in recent months.

Incoming wave of mortgage renewals

Additionally, delinquencies are on the rise, signalling increasing financial stress among borrowers. Tal notes that arrears are rising across various forms of consumer credit, from credit cards and auto loans to mortgages.

As has now been widely reported, challenges for mortgage borrowers are only expected to intensify in the coming years due to the large number of low-interest rate fixed terms that are set to renew.

CIBC’s research suggests 50% of outstanding loans have reset to higher rates, which still leaves more than $1 trillion worth of mortgages to renew in the coming years.

“Based on term distributions and our interest rate forecast, we estimate that the average interest payment shock in 2024-26 will amount to around 15% a year,” Tal writes. However, he says the key word is “average,” with some borrowers who are now in shorter terms seeing their rates actually fall in the coming years, and others experiencing a much sharper payment shock.

The average “masks the pain at the margins — where credit risk resides,” Tal notes.

While one has to “dig deep” to find early signs of credit vulnerability, Tal says they do exist. Early-stage delinquencies in the below-prime mortgage space are “rising strongly;” non-mortgage debt held by homeowners is well above 2019 levels with half of all mortgages yet to be repriced; and renters are being impacted to a greater degree by the weakening labour market and rising rents.

Reasons for optimism

Against this backdrop, Tal has found some silver linings that suggest we may be headed for more of a “squeeze on spending” as opposed to a “large potential credit risk event.”

For one, while insolvencies are up over 20%, Tal says they’re rising from a “very tame” level. Additionally, a record high of 80% of those insolvencies are proposals, which involve restructuring the debt, rather than outright bankruptcies.

“That’s important because the legal costs and the losses per proposal are lower for lenders than in bankruptcies, and the recovery rate is much higher,” he says, meaning financial institutions aren’t seeing their loss rates spike.

There also appears to be “increased communication and coordination” between lenders and borrowers based on the fact that 30- to 60-day delinquencies are rising, while the share of those moving to the 60- to 90-day category is actually on the decline.

“Also encouraging is the fact that the share of mortgages that are in a trigger rate
position (a situation in which interest payments account for 100% of debt service payments) has been falling steadily in recent months,” Tal adds. “That early treatment of the symptoms was not seen in previous recessions.”

The bottom line? Yes, there are signs of stress among borrowers—both homeowners and renters alike—and delinquencies are expected to continue to rise in the coming quarters.

“But the fact that we had to dig deep to find signs of stress, combined with our expectations that the unemployment rate will not exceed 6.5%—miles below the rate seen during recessionary periods in the past, means that upcoming credit losses will be manageable,” Tal says.

This article was written for Canadian Mortgage Trends by:

National Bank of Canada, the country’s sixth-largest bank, saw a rise in mortgage delinquencies during the first quarter, with the largest increases contained to its insured variable-rate mortgage portfolio.

The bank reported the percentage of residential mortgages that are behind on payments by at least 90 days rose to 0.13% in Q1, up from 0.11% in Q4 and just 0.8% a year ago.

However, it’s the clients with variable-rate mortgages, who represent 28% of the bank’s $91.3 billion residential mortgage portfolio, that are finding it most challenging to keep up with their payments.

National Bank, like Scotiabank, offers adjustable-rate mortgages, where the borrower’s monthly payment fluctuates as prime rate changes. As a result, the bank’s floating-rate clients have already experienced payment shocks brought on by the sharp rise in interest rates over the past two years.

Its fixed-rate clients, on the other hand, will only see their interest rates increase at renewal time.

The delinquency rate for National Bank’s variable-rate clients jumped to 0.21% of its portfolio from 0.14% in Q4 and 0.07% in Q3. That’s now on par with its pre-pandemic rate of 0.21% reported in Q1 of 2020.

“Variable-rate mortgage delinquencies have continued to normalize as borrowers have absorbed a significant increase in interest rates,” Chief Risk Officer Bill Bonnell said on the bank’s earnings call this week.

“Where the delinquencies have…increased the fastest is where there’s been more leverage in the consumers,” he added, pointing to the delinquency rate of 0.32% for its insured variable-rate borrowers vs. 0.17% for their uninsured mortgage counterparts.

“Typically the insured mortgage holder is a first-time buyer [who] doesn’t have the 20% down payment,” Bonnell added. “And so, it’s not a surprise that we see a differentiation between the delinquency trends for insured…and uninsured variable rate [mortgages].”

Looking ahead to fixed-rate renewals

As for the the bank’s fixed-rate mortgages, just 12% of its portfolio will be coming up for renewal in 2024, with the bulk of renewals coming in 2025 (27%) and 2026 (38%).

National Bank estimates those with renewals this year will face a payment increase of around 15%, or between $200 and $300. Those renewing in 2025 and 2026 are likely to see slightly higher payment increases of 22% and 18%, respectively, or between $250 and $400.

“As we look ahead at what will happen upon renewal for the fixed rate mortgages, there are a lot of metrics…which give comfort.,” Bonnell said.

“When you look at the nature of those fixed rate mortgages for 2025 and 2026 renewal, there’s a high percentage which are insured [and have] a relatively low loan-to-value, which provides flexibility for the borrower or depending on where rates are at the time,” he continued, saying they typically have high credit scores as well. “So, we’re quite confident in the resiliency of those borrowers.”

Quebec borrowers show greater resiliency to payment shocks

Bonnell also addressed some regional differences, noting that delinquencies on average are lower in Quebec.

“In our portfolio, we do see Quebec consumers appearing to have more resilience and [are] performing better on a delinquency basis,” he said.

He pointed to lower average home prices in the province, which means “lower mortgages, so less consumer leverage, more dual incomes [and a] diversified economy.”

“It generates factors that support resiliency in our mortgage borrowers and that’s coming through in the numbers,” he added.

National Bank earnings highlights

Q1 net income (adjusted): $922 million (+5% Y/Y)
Earnings per share: $2.59

Conference Call

• “Growth in personal loans remained slower, reflecting a lower level of mortgage originations. We will continue to be disciplined across our portfolio, balancing volume growth with margin and credit quality,” said President and CEO Laurent Ferreira.
• “Looking ahead, we expect delinquencies and impaired provisions to continue their upward path,” said Chief Risk Officer Bill Bonnell.
• National Bank’s base case economic forecast has the unemployment rate in Canada increasing to about 7% by early 2025.
• “Credit card delinquencies now exceed their pre-pandemic level. Within this population, we find the client segment most impacted has been non-homeowners, a segment that has been absorbing significant increases in rental costs,” Bonnell said.

Source: NBC Conference Call

Note: Transcripts are provided as-is from the companies and/or third-party sources, and their accuracy cannot be 100% assured.

Feature image: Roberto Machado Noa/LightRocket via Getty Images

This article was written for Canadian Mortgage Trends by:

RBC’s executive team today expressed confidence in its due diligence of HSBC Canada’s mortgage portfolio during the $13.5-billion acquisition.

The question arose on today’s first-quarter earnings call in the wake of whistleblower allegations of a mortgage fraud scheme at HSBC Canada’s Greater Toronto operations prior to RBC’s acquisition of the bank.

The allegations were first reported by journalist Sam Cooper at The Bureau and have caught the attention of Simcoe North MP Adam Chambers, who is calling for an investigation of the allegations.

“[Going back] to the diligence we did at the inception of transaction, credit was a huge part of our focus there,” said Chief Risk Officer Graeme Hepworth.

“We brought a lot of people into the room on that from the risk management side and the business side to go very deep on their portfolios, [and] really understand their mortgage portfolio, their commercial portfolios,” he continued. “We did that from both an aggregate portfolio view as well as right down to reviewing and understanding the underwriting they did on sample portfolios there.”

Through that process, he said RBC’s team was “very comfortable” with the credit quality of the portfolio.

“If anything, it skews a little bit better than some of our portfolios. The nature of their retail client base is a fairly high net worth one and so that tends to skew well,” he added. “We felt really good about the diligence we did at the time. Obviously, we’ll get the full details…But I don’t think at this point in time we’ve seen anything that was new there that would cause us concern.”

RBC’s acquisition of HSBC’s Canadian unit cleared its final hurdle in December after receiving approval from Chrystia Freeland, Deputy Prime Minister and Minister of Finance. The deal is expected to close by March 28.

Amortization periods coming back down

Continuing a trend seen in recent quarters, RBC reported a continued decrease in the remaining amortization periods for its residential mortgage portfolio.

In late 2022 and early 2023, banks that offer fixed-payment variable-rate mortgages, like RBC, TD, BMO and CIBC, saw the amortization periods for those mortgages spike dramatically as interest rates soared.

In most cases, however, the mortgage reverts to the original amortization schedule at renewal, which typically results in higher monthly payments unless borrowers take proactive payment action.

In Q1, RBC saw the percentage of mortgages with a remaining amortization above 35% ease to 22% of its portfolio, down from a peak of 26% a year ago.

RBC residential mortgage portfolio by remaining amortization period

RBC earnings highlights

Q1 net income (adjusted): $4.07 billion (-5% Y/Y)
Earnings per share: $2.85

Conference Call

• “Mortgage growth declined to 3% year-over-year as a strong retention rate offset continued pressure on home prices,” said President and CEO Dave McKay. “While we anticipate some continued recovery of housing resell activity, we expect mortgage growth to remain in the low-single digits through 2024, as we remain disciplined on pricing and spreads amidst intense competition.”
• “The market continues to gain confidence that interest rates have peaked for the current cycle, and the probability of a hard landing for the economy is decreasing,” said Chief Risk Officer Graeme Hepworth. “Notwithstanding an improving macroeconomic outlook, we continue to see credit outcomes deteriorating as the lagging impact of interest rate increases takes hold for more clients.”
• “In our retail portfolio, delinquencies, insolvencies, and impairments continue to increase, with delinquencies and impairments above pre-pandemic levels,” Hepworth added.
• In our Canadian Banking retail portfolio, provisions on impaired loans were higher across all products, led by credit cards. The increases in unemployment rates we observed through 2023, and the impact of higher interest rates are now translating into losses,” Hepworth said. “Our current forecast on unemployment is we have that ticking up fairly significantly from where we are now [5.7%] to about 6.6% mid-year 2024.”
• On the HSBC Canada acquisition:
  • Following the expected close of the bank’s acquisition of HSBC Canada by March 28, RBC said it expects its CET1 ratio to be approximately 12.5% by the end of the quarter.
  • “With this transaction, RBC will be better positioned to be the bank of choice for commercial clients with international needs, affluent clients needing Wealth Management capabilities, and newcomers to Canada,” McKay said.
  • RBC expects about $740 million of expense synergies, with 80% of those synergies realized in 2025.
  • “We do see [the HSBC acquisition] as, obviously, a very profitable and a very attractive client set [and] we continue to be impressed with the capabilities HSBC has brought, but we do see opportunities to bring products to the table that they don’t have,” said Neil McLaughlin.

Source: RBC Q1 conference call

Note: Transcripts are provided as-is from the companies and/or third-party sources, and their accuracy cannot be 100% assured.

Featured image by Gary Hershorn/Getty Images

This article was written for Canadian Mortgage Trends by:

The Bank of Canada is still likely to wait until mid-year before delivering its first rate cut, despite January’s downside surprise in inflation, economists say.

Headline inflation came in below expectations with a 2.9% reading in January against expectations of 3.3% and December’s 3.4% pace. It’s the first time the headline CPI reading has fallen below 3% since June 2023 when it dipped to 2.8%.

The slowdown was driven largely by lower energy prices, specifically a 4% annual decline in gas prices, and a cooling of grocery prices, which came in at 3.4% compared to 4.7% in December.

“There is little debate on this one—it’s a much milder reading than expected, especially given the high-side surprise seen in last week’s round of U.S. inflation reports, a nice contrast,” wrote BMO chief economist Douglas Porter.

“Importantly, January can set the tone for inflation,” Porter added, “since firms often take the opportunity to adjust prices for the year in this month—and there was little sign of a big January bump this year.”

The Bank of Canada’s preferred measures of core inflation, which strip out food and energy prices, also trended downward. CPI-median eased to 3.3% (from 3.5% in December), while CPI-trim fell to 3.4% from 3.7%.

Shelter costs keeping upward pressure on inflation

Unsurprisingly, shelter costs continue to exert upward pressure on inflation, and actually rose in the month to an annualized +6.2% from +6% in December.

An ongoing supply-demand imbalance is also keeping upward pressure on rent inflation, which picked up to 7.8% from 7.5% in December. As we reported last week, average asking rents were up another 0.8% month-over-month to a record $2,200.

The Bank of Canada’s own interest rate hikes are also continuing to work their way through the economy, with the mortgage interest cost component of the CPI basket up 27.4% year-over-year.

“Shelter inflation has become the biggest hurdle preventing the Bank from cutting interest rates,” TD economist Leslie Preston wrote in a research note.

“Shelter inflation will remain sticky as higher interest rates feed through to mortgage interest costs with a lag, and undersupply of housing continues to boost rent prices,” RBC economists Nathan Janzen and Abbey Xu wrote. However, “the most likely path for inflation going forward is still lower with per-capita GDP and consumer spending continuing to decline,” they added.

What the inflation figures mean for Bank of Canada rate cuts

Most economists say the first Bank of Canada rate cut is still on track for its June 5 meeting, believing the central bank will want to see additional signs of easing inflation pressures.

“While no doubt welcome news, the Bank of Canada will likely remain cautious in the face of still-strong wage gains, firm services prices, and the reality that core inflation is still holding above 3%,” Porter wrote. “But clearly today’s result makes rate cuts much more plausible in coming months.”

RBC’s Xu and Janzen pointed out that stronger-than-expected job gains in January are another factor that will likely keep the Bank on the sidelines for now.

“A strong start to 2024 for labour markets gives the BoC more leeway to wait for firmer signs that inflation is getting back under control before pivoting to interest rate cuts,” they wrote. “As of now, our base case assumes the BoC starts to lower interest rates around mid-year.”

Earlier this month, Bank of Canada Governor Tiff Macklem told a parliamentary finance committee that the central bank doesn’t need to wait until inflation is all the way back to its neutral target of 2% before it starts cutting rates.

However, he added that “you don’t want to lower them until you’re convinced…that you’re really on a path to get there, and that’s really where we are right now.”

Following today’s inflation release, bond markets raised their rate-cuts odds slightly. They are currently pricing in a 29% chance of a quarter-point cut in March, and an 11% chance of 50 bps worth of easing by June.

This article was written for Canadian Mortgage Trends by:

Canadian home sales continued their upward trend in january as prices fell modestly

The Canadian Real Estate Association announced today that home sales over the last two months show signs of recovery. National sales were up 3.7% between December 2023 and January 2024, building on the 7.9% gain in December. The chart below shows that despite the two-month rise, sales remain 9% below their ten-year average. According to Shaun Cathcart, CREA’s Senior Economist, “Sales are up, market conditions have tightened quite a bit, and there has been anecdotal evidence of renewed competition among buyers; however, in areas where sales have shot up most over the last two months, prices are still trending lower. Taken together, these trends suggest a market that is starting to turn a corner but is still working through the weakness of the last two years.”

National gains were once again led by the Greater Toronto Area (GTA), Hamilton-Burlington, Montreal, Greater Vancouver and the Fraser Valley, Calgary, and most markets in Ontario’s Greater Golden Horseshoe and cottage country.

The actual (not seasonally adjusted) number of transactions was 22% above January 2023, the most significant year-over-year gain since May 2021. While that sounds like a resounding rise in activity, January 2023 posted the weakest transaction level in nearly twenty years.

There is pent-up demand for housing, and recent buyers are lured back into the market by the recent price decline and the fear that prices could rise significantly once the Bank of Canada starts cutting interest rates.

New Listings

The number of newly listed homes increased 1.5% month-over-month in January, although it remains close to the lowest level since last June.

“The market has been showing some early signs of life over the last couple of months, probably no surprise given how much pent-up demand is out there,” said Larry Cerqua, Chair of CREA.

With sales up by more than new listings in January, the national sales-to-new listings ratio tightened further to 58.8% compared to under 50% just three months earlier. The long-term average for the national sales-to-new listings ratio is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets, respectively.

There were 3.7 months of inventory on a national basis at the end of January 2024, down from 3.8 months at the end of December and 4.1 months at the end of November. The long-term average is about five months of inventory.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) fell by 1.2% month-over-month in January 2024, adding to the 1.1% price decline in December.

Price descents of late have been predominantly in Ontario markets, particularly the Greater Golden Horseshoe and, to a lesser extent, British Columbia. Elsewhere in Canada, prices are mostly holding firm or, in some cases (Alberta and Newfoundland and Labrador), continuing to rise.

The Aggregate Composite MLS® HPI was up 0.4% year-over-year in January 2024, similar to readings over the past six months.

Bottom Line
Sales in December and January generally run at about half the peak spring season pace. That could be especially true this year, with interest rates likely to begin falling by mid-year. A strong housing rebound is coming. Housing markets have bottomed, buyer sentiment is improving and fixed mortgage rates have started declining.

Housing markets in Toronto, Vancouver and Montreal are relatively balanced again, and with the spring season, we will see a rise in new listings.

In other news, the inflation data released yesterday in the US were higher than expected, pushing rate-cut forecasts further out. With the strength in the US economy, the 5-year government of Canada bond yield has quietly risen more than 50 basis points this year.

Canada’s Housing Minister, Sean Fraser, said he expects the fall in interest rates this year to encourage builders to ramp up their activity, helping to alleviate some of the country’s crunched housing supply. At a news conference yesterday, the minister said, “My expectation is if we see a dip in interest rates over the course of this year, a lot of the developers that I’ve spoken to will start those projects that are marginal today.”

Sean Fraser, asked whether he’s concerned that Bank of Canada rate cuts will unleash pent-up demand and higher home prices, said lower borrowing costs should also lead to an increase in supply. Fraser said whatever happens with rates, the government’s course of action will remain the same. “We need to do everything we can as quickly as we can to build as many homes as we can. And that’s going to be true today and six months from now, regardless of what may happen in the interest rate environment that we’re dealing with.”

At a news conference last week, Bank of Canada Governor Tiff Macklem said that while he’s heard from developers who’ve indicated higher rates are delaying projects, lowering rates would have a more significant impact on demand.

“It’s very clear in the data that the effects of interest rates on demand are much bigger than those on supply,” he told reporters.

When the Canada Mortgage and Housing Corporation (CMHC) announced that Canada would need an extra 3.5 million homes by 2030 to keep up with demand, the figure was already staggering.

But a new report from CIBC deputy chief economist Benjamin Tal suggests the housing supply gap is even worse than first thought.

In his research note entitled, ‘The housing crisis is a planning crisis,’ Tal argues that the total number of homes needed by 2030—above and beyond the current pace of construction—is actually closer to five million homes.

He said the discrepancy is due to a lack of proper planning around population, with growth targets consistently falling short of reality. The biggest reason for this, he explains, is an under-estimate of non-permanent residents, which he says make up more than 90% of the forecasting gap.

“You cannot build an adequate supply of housing for population growth that you fail to forecast,” Tal wrote.

“That significant forecasting/planning gap is a direct result of the fact that currently there are no credible forecasts, targets, or capacity plans across governments for non-permanent residents—the population which accounts for the vast majority of the planning shortfall,” he added. “That must change.”

Can’t plan for what’s not in the plan, Tal says

Tal notes that the planning process for municipalities to accommodate future growth is a lengthy process, taking up to a decade to “identify, service and allocate land for housing, then [to] auction that land for developers to construct and sell housing units on.”

“Therefore, accurate forecasts of population growth are key for adequate housing supply.”

But past forecasts have regularly missed the mark.

“That was a big miss,” Tal said. “The reality is that today municipalities are facing 1.4
million more people than they were told they needed to plan for— in total that’s a shortfall of almost three years of housing supply.”

Even more recent population forecasts have failed to keep up with the rapid pace of population growth, with Statistics Canada’s August 2003 projections falling short by roughly 700,000 people.

What can be done?

Last month, Immigration Minister Marc Miller announced a national cap on the number of international students accepted into the country, which is expected to reduce intake by about 35% to a total of 364,000 students in 2024.

While Tal called the measure a “bold move in the right direction,” he says more still needs to be done.

“Even if the cap works as designed, the strong pace of growth of other non-permanent residents would keep Canada’s population growth closer to 2% annualized growth,” Tal says, which is above CMHC’s current 1.5% annual growth projections for the next seven years, or about six million additional international arrivals beyond what is forecast.

What is most needed, Tal argues, is “meaningful forecasting and integrated planning” that is applied to all permanent and temporary visa approvals.

“A full matrix of targets by application type and year, as exists for permanent residents, is an essential step to assist planning at all levels, for the Ministry of Housing, provinces/territories, municipalities, as well as for the development industry,” Tal says. “Transparent, timely, and vetted [forecast] sourcing is key.”

This article was written for Canadian Mortgage Trends by: