Canada’s banks developed a global reputation as some of the most prudent in the world after 2008. It’s a factor that makes it hard for many to believe there’s a real estate bubble—the country’s responsible banks just wouldn’t allow it, right? Unfortunately, the only thing Canada’s banks learned is they’re too big to fail, and people don’t pay attention to the details. Here’s four issues propping up the real estate bubble, that make 2008 America look like an aspirational model for banking in the West.
Canadians Make Interest Only Mortgages Look Responsible
Canada’s banks issued such large mortgage loans, households can’t make the interest payments. About 1 in 4 mortgages have remaining amortizations of 35 years or longer at the five largest banks, as per their Q2 2023 filings. Not a data point that caused many to bat a lash, since most don’t realize the maximum amortization for a new borrower is only 30 years.
That means these loans saw negative amortization—when payments fail to cover interest, so the term lengthens. The regulator wasn’t too impressed, but warned removing the ability may cause defaults and downward pressure on home prices. Young adults struggling to pay rents because overleveraged borrowers need to retain equity, must be the hallmark of prudent risk management.
At Least One Major Bank Is Having Its Mortgages Discreetly Audited
Canada’s bank regulator has ordered a Big Five to fix its mortgage underwriting. This week the Globe reported OSFI has been auditing CIBC for over a year, after finding mortgage portfolio breaches. The bank was found failing to limit the amount borrowers can handle, leading to overleveraged borrowers. The bank doesn’t know the extent, but the paper reported that internal estimates will take years more to resolve the issue.
Over 1 in 5 New Mortgage Borrowers Push Their Payment Limit
Canada’s banks are taking on borrowers that are very highly leveraged. The gross debt service (GDS) ratio is the share of income before taxes, dedicated to debt repayment. Having a GDS in excess of 39% means the borrower is pushed to their limits.
The bank regulator previously expressed concerns regarding the volume of loans exceeding 39% GDS. Last year, after rates began climbing, over 1 in 5 mortgages (21.3%) qualified their mortgage with a 39% or higher GDS. No wonder any slight hiccup is causing extended amortizations, and risk of default.
Nearly A Third of New Mortgage Borrowers Are Overleveraged
Speaking of overleveraged borrowers, Canada’s bank regulator has repeatedly warned on this issue. Borrowers with a loan-to-income (LTI) greater than 450% are considered overleveraged. OSFI’s most recent public dive shows nearly a third (32.1%) of new mortgages in Q3 2022 were to overleveraged borrowers by this definition. Once again, as rates began climbing and it was clear they would continue to march higher, Canada’s banks were loading up borrowers already pushed to their extreme.
We can debate until we’re blue in the face on whether this is an issue of reckless borrowers or lenders. However, regardless of who’s at fault, it presents a risk to the country’s financial system and general economy. An affordability crisis is propped up by reckless lending, and taxpayers will be on the hook for that fallout.
The fact OSFI has repeatedly warned of issues but can’t reel them in is a sign that Canada’s banking system needs reform. It doesn’t matter how good a watchdog is if it’s muzzled and doesn’t have the freedom to act.