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Many homeowners and consumers who are in debt can no longer pay their mortgages and have filed for bankruptcy. As all this money initially came from Canadian banks, can these numerous bankruptcies shake their stability, wonders Hélène Dufresne?
A residential mortgage loan is among the safest assets for an issuing financial institution, especially since the loan is based on property offered as security that is normally of high quality.
As recently as last November, the Canada Mortgage and Housing Corporation indicated in its quarterly analysis that the average loan-to-value ratio of newly granted mortgage loans remained stable, and that delinquent loan rates remained relatively low, even if an increase was observed in the provinces (Ontario and British Columbia) struggling with overheating and a sharp rise in prices.
Banks are subject to very strict capitalization standards. In addition, in a context of deterioration in economic activity, they will tighten their credit conditions and make significant provisions for bad debts in order to prevent blows.
Financial test
For mortgage loans, it should be noted that the Office of the Superintendent of Financial Institutions (OSFI), which regulates federally chartered financial institutions, imposes a financial test aimed at better measuring the quality of the borrower. The minimum qualifying rate for uninsured mortgage loans is established based on the higher of the contractual mortgage rate plus two percentage points or 5.25%. Banks also require mortgage loan insurance when the down payment is less than 20%.
Last year, OSFI was concerned, in particular, by the skyrocketing loan-to-value ratios exceeding 100%, citing in particular the proliferation of negative amortization which emerges from accounts with variable rates and fixed payments of five years. For prudential purposes, institutions were asked to hold more capital under negative amortization mortgages. The new requirements also affected mortgage insurers.
Last resort solution
Finally, in cases of insolvency, indebted people with property will do everything to avoid losing this important asset, especially if its value contains a positive net worth. They will extend the amortization of their mortgage loan and work first to consolidate their non-mortgage loans. Selling the property will always remain a solution of last resort.
In 2023, we observed that unlike corporate insolvency cases, where the bankruptcy route was widely used, more than three quarters of consumer cases were based on a proposal made to creditors. This solution is used in particular when bankruptcy can be avoided, but also when there is an asset on the balance sheet that we want to protect.
As for the exposure of investment funds to the banking sector, Canadian financial institutions in general, and banks in particular, are sought-after investments for their long-term growth potential. This is true even in a recession, if only for the dividend yield offered. Since banks only lower their dividend payments in cases of force majeure, this yield increases if the share price falls.