Record household leverage is a concern, but Canadian banks are well positioned to withstand a negative economic shock, says a new report from UBS Securities Canada Inc.
In a new research report, UBS notes that record high household leverage, and high house prices, are reasons to be concerned, particularly amid an uncertain macro outlook, sovereign risks, and record low interest rates.
However, it suggests that the risk is moderate due to mitigating structural factors. “We think conservative underwriting, low loan-to-value ratios, high returns, strong capital, and a better fiscal backdrop provide resilience,” it says, pointing out that over two-thirds of Canadian household debt is in lower risk residential mortgages, and approximately 20% is in personal lines of credit, most of which are secured with real estate, also under strong underwriting standards.
Even if house prices were to drop 25%, UBS estimates mortgage losses would only amount to 10-12 basis points, up from 2 bps currently. And, it projects that a doubling in overall loan loss provisions to 80 bps, would only result in a 15-20% decline in earnings per share, and would still leave the banks with a 14% return on equity.
“Economic vulnerability to high consumer leverage and external shocks remain concerns,” UBS says. “However, we think credit risk is moderate, due to mitigating factors. Nonetheless, growth will slow.” The biggest risks, it suggests, are overall financial system risks.
Against this background, the report concludes, “Given modest projected Canadian consumer growth of under 5% per year, we think that international growth, capital deployment, and high returns, will matter most. We also think that expense control will increasingly be important. While business lending is expected to increase in importance; this not likely investable short-term due to modest differences between banks.”