Four Reasons Canada’s Real Estate Bubble Is A Systemic Banking Risk

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.

10 Comments

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  • Dennis_K 12 months ago

    One thing I noticed about the audit regarding CIBC’s over-leveraged borrowers — it assumes that the data they have on (all) the borrowers is accurate. If persons have misstated incomes, debts, assets, etc. (possibly thanks their own dishonesty or unscrupulous mortgage brokers), then this risk is higher, not just for CIBC, but all
    lenders, no? Hence the ‘systemic banking risk’ the title of the article refers to, yes?

  • Hubba Bubba 12 months ago

    “The regulator wasn’t too impressed, but warned removing the ability may cause defaults and downward pressure on home prices. ”

    Downward pressure on prices is exactly what we need right now, no??? Prices have ballooned since Easter to insane heights… how much longer can this keep going? We should let nature take its course, i.e. banks should stop rescuing underwater borrowers and just let them drown, sink to the bottom, which would help bring prices down to more affordable levels. Who would ever have thought the average price of a standard shack 200-300 km outside of the GTA would be one million…

  • AllenB 12 months ago

    What a mess. A system doing everything possible to protect homeowners, speculators and investors for as long as possible on the backs of renters who are fast being driven into poverty.

    Borrowers are being allowed to push out their mortgages into negative amortization territory, but no such luck for renters, many of whom in the GVRD are now paying more than 50% of gross income on rent.
    By comparison only 39% GDS seems positively luxurious.

    Ironically, the very same investors and speculators that drove property to the stratospheric prices we are now faced with, making it impossible for renters without family money to get a foothold in the market, are the same ones that are pushing up rents faster than ever, and the same ones that the banks are doing their utmost to protect.
    The BUBBLE NEEDS TO BURST, just sooner rather than later. The current system is not sustainable and is fast creating a class system of “landed gentry” with serfs to serve.

  • Willynilly 12 months ago

    The Quiet before the Storm…………

  • M.Bury 12 months ago

    1. The mortgage stress test was supposed to protect against this very problem, you know, by approving only people who could afford higher rates.
    2. Many people (you know to whom I’m referring) criticized the stress test’s validity because interest rates would never go up.

  • Scott 12 months ago

    Wow! Is this how a “Post Nationalist State” economy is supposed to work?

  • Scott 12 months ago

    And an ad for CIBC just popped up on my screen…

  • Kimberley Hedger 12 months ago

    Remove homes/residential property from the Banks stock market shares. Only allow shares in banks be based on the productivity of our businesses and manufacturing.

  • pw 12 months ago

    I disagree with the analysis here – these longer amortization periods aren’t due to negative amortization, but the structure of most variable rate mortgages.

    Higher rates and fixed monthly payments = longer amortization. It’s still a big concern, but I don’t think the data as presented supports the conclusion.

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