RBC Just Forecasted Mortgage Defaults May Be Higher Than If The BoC Did Nothing

Canada’s largest bank is prepared for the wave of mortgage defaults coming. Phew! Wait… what defaults? RBC Capital Markets sent a research note to clients last week. In it, the analysts mention up to a fifth of deferred mortgages are at risk of default. It’s great the bank is well prepared for this event, but it does bring up a lot of questions. Most notably, how effective are the Bank of Canada (BoC) policy measures? After all, the default rate RBC is forecasting is higher than the BoC said would happen if they did nothing at all.

One In Five Mortgages Deferred May Default In Canada

RBC sent a research note to institutional clients that mentions upcoming mortgage defaults. In the research note, they state “we believe 10% to 20% of mortgages under deferral are at a higher risk of defaulting.” Further adding, “if 20% of mortgages under deferral eventually become delinquent in Canada, this equates to a mortgage delinquency rate of 2.3% which is almost 4 times higher than the peak Canadian mortgage delinquency rate over the past 30 years.” Even at that rate, it’s still relatively low in the grand scheme of things. However, as the analysts note, it’s higher than Canada has seen in recent history.

They also present reasons why it can be on the lower end, as well as the higher end. One potential reason they believe Canada may see lower levels, is the savings rate. By their calculations, they believe people saved about 4-6 months of mortgage payments. An argument for it to be higher is some people may be struggling with payments that weren’t deferred. It’s not going to be totally clear where the numbers land, until support measures begin to fade.

Much Higher Than Bank of Canada Expects

Let’s circle back to what the BoC is expecting. They forecasted their policy measures would reduce the quarterly arrears rate to peak at 0.79% in Q3 2021. Without policy measures, they believed the arrears rate would have increased to 2.11% by Q4 2020. In other words, they believed deferrals and QE would drastically reduce mortgage defaults.

Canadian Mortgages In Arrears Forecast

The rate of mortgages in arrears forecasted by the Bank of Canada, and the impact recently implemented policy measures are expected to have.
Source: BoC, Better Dwelling.

RBC Forecasted An Outcome Similar To No Measures

The BoC’s forecasted peak deferral rate without policy measures, is lower than RBC’s recent analysis. Which brings up some interesting questions about the policy measures. The combination of deferrals and QE may have seemed like a logical move. The former gave sellers more time, and the latter gave buyers cheap money to buy  homes from distressed sellers. Makes sense, right?

What this plan didn’t account for is the behavioral response to stimulus measures. QE increases buyer liquidity, but also tends to inflate asset prices. The BoC’s bond buying didn’t just give buyers access to cheap money. It made the homes of people that couldn’t pay their bills worth more. The average person tends to hold on to assets as they rise in price. Selling usually occurs after prices fall. The BoC essentially created an environment that encouraged sellers to HODL. Not sell.

“Fortunes are made by buying low and selling too soon.”

–Nathan Rothschild

If everyone knew when to sell at peak value, they would all be rich. In reality, non-professional investors typically hold assets too long. This tends to wipe out some (or all) of their gains, before they feel sufficient reason to sell. This is also the only reason to default on a mortgage, to be totally honest. You only default if you can’t pay your bills, and hold on too long. No one ever went broke taking a little off the table. A lot of people have gone broke leaving it all on, waiting for a perfect hand.

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  • LT 4 years ago

    Even the “with policy” rate of defaults, Canada is looking at a big increase. Multiples higher than any other recession.

    • Trader Jim 4 years ago

      Defaults aren’t as important to the market as distressed selling. The longer people wait post-deferral, the longer they’re likely to have to discount.

      IMO, this impacts investors over the past few years, more than regular people. The average mortgage in Canada is only $1,500. They would carry that on CERB or whatever the replacement is. They won’t be able to carry a $4k mortgage they’re hoping for two people to rent at $3k/piece.

      • Ethan Wu 4 years ago

        About that. I pay around that, for what buyers are paying about 4x now. They’re insane.

      • The Truth Shall Set You Free 4 years ago

        Maybe in Canada the average is what you mention but the average mortgage in the GTA is around 600,000. That means payments of around 2,500 a month plus taxes plus maintenance (if non-freehold town or condo) plus plus plus. Had a discussion with a mortgage broker friend who I haven’t spoken with in some time prior and we got on the topic of what’s been going on and he stated the following: “Average mortgages are 600k. In order for a person to qualify for 600k they have to have a yearly family income of 120k. A lot of people don’t have that and the banks know but they give them mortgages.” This is a house of cards in an open field right now waiting on a gust of wind. Forecast calls for a tornado…

        • Groot 4 years ago

          It’s not the banks that are approving these people it’s private mortgage lenders who are funding second mortgages behind the banks first mortgage. The bank turns a blind eye to the second mortgage or doesn’t do enough due diligence to ask more questions and just lets their deal fund. On paper the banks debt ratios look fine because they are “unaware” of the second mortgage registered behind them. There are 2 motives for the bank allowing this even though they are not supposed to.

          1- A second mortgage acts as a form of insurance for the 1st mortgage lender in the event of default. Basically the second mortgage lender is fully exposed and would thereby buy out the first 1st mortgage lender and take over control of the power of sale.

          2 – The banks needs to get the money let out a.s.a.p. while making their books look good. Since their mortgage will fall within guidelines assuming no knowledge of the second mortgage they can fund their deal.

          Bottom line is private money is driving this market way more than most peaple realize and there is little to no way to track it under the current systems in place.

  • Ethan Wu 4 years ago

    Condo buyers are going to take the most of this hit. At which point, it will become even more frustrating to pay the cost of almost rent on top of a mortgage.

    Build for investors, and lose the market when they leave.

  • Kolf 4 years ago

    I work for the big fives, yes I worked in not just one of them. From risk management perspective it would be insane to keep giving deferrals to high risk customers. This is call deferral risk, not default risk. This refers to when a large number of deferrals turning into defaults at the same time. Smart banks will use their analytic teams to identify most likely to default customers and refuse deferral and foreclose and put those properties on to market before the big wave hits.

    For example “investment” properties purchased recently by people who are in vulnerable industries.

    • The Truth Shall Set You Free 4 years ago

      Many people don’t care to understand the facts of what is going on. Even though you work inside and know what’s going to come. They believe that the government will never forsake them and as such keep believing that real estate is too big to let fail. This will be a collapse like none before and will devastate the entire middle class as well as some of the low high class.

      • Kolf 4 years ago

        Actually, the real estate market is not too big to fail from banks perspective, yet (first order impact anyways). Thats because the price increases are in a few cities only and unaffordable prices were not for a very long time. So its only a moderate percentage of the mortgage portfolio. So the overall damage to banks will not be significant enough to break the banks. Even if prices fall 50% in Toronto and Vancouver (thats merely back to 5 years ago levels) Canadian banks can withstand it with their provisions. Of course the real estate industry and the media will scare you into the opposite direction.

        However, the big nuke will drop if the government continues to prop up real estate, few more years at these price levels the mortgage portfolio will be too big to withstand any price decrease. So I urge the government to be honest and let real estate prices deflate in Toronto and Vancouver these two years before it becomes too big to deflate.

        We are all screwed if the government dont take action now. This is a good time to let prices fall because there is no capital flight since the u.s is a mess. We can redirect these excess funds from real estate speculator sales into our real economy.

    • SH 4 years ago

      The banks didn’t opt to give the deferrals of their volition. The federal government and the anti-capitalists at the CMHC FORCED the banks to grant deferrals to both end-users and landlords.

      This was a despicable act of injustice on the 30% of Canadians who rent. Mortgage borrowers got a government-mandated 6 month holiday from their financial obligations pertaining to housing, no questions asked and not even impacting their credit score, while renters got zilch.

  • Fight Back 4 years ago

    The government needs to stop propping up unaffordable markets like Toronto and Vancouver. Anyone who owns multiple residential properties should not get any assistance. People who own multiple residential properties in Toronto needs to be taxed.

    We need to punish speculators and corrupt politicians who protect them.

    • Paul 4 years ago

      We don’t need to tax owners who own kore than one property but a vacancy tax is a great idea.

      In this case the bubble will sort of multiple property owners and if you create a system to cost land jobbers money on a yearly basis they will have to consider the expense of keeping those properties empty to drive up prices.

      I also think that short term rentals should count as vacant properties. If there is no one registered as living there full time.

      If we had something like that in place maybe we wouldn’t be looking at so many defaults as I’m sure the air bnb investors doubled down during the last two years and purchased multiple properties.

      • Pepp 4 years ago

        Look, vacancy tax will not solve the problem. Why? Because if the prices dont come down the cost of land to build more housing will not come down. The further prices increase the more expensive it is to create more supply. Hence we need a measure to bring down prices, which will increase supply. Vacancy tax is useless, look at Vancouver.

  • C.D.R. 4 years ago

    @SH, mortgage deferrals still need to be paid WITH MORE INTEREST, so it’s not a free lunch.

    BTW rents in Toronto, Vancouver and couple other metro areas are down substantially – 25+%, so not exactly zilch. While the landlord still has to pay the same amount on mortgage.

    I’m all for substantial (down 25-50%) R/E price and rent corrections but don’t play the fake “renter got zilch” pity party.

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