The big Canadian banks would hold up much better in a severe housing market crash than their U.S. counterparts did during the financial crisis, says Moody’s Investors Service in a report published on Monday.
“Increasing household debt and rapidly increasing home prices in Canada demonstrate conditions similar to the U.S. leading up to the financial crisis,” the report says.
However, the report adds that “significant structural differences between the Canadian and U.S. mortgage markets mean that the largest Canadian banks would be able to absorb the direct effects of a severe housing crisis without incurring catastrophic losses.”
In particular, government-guaranteed mortgage insurance, lower rates of “subprime lending”, and the lower prevalence of “originate-to-distribute” securitization practices, differentiates the Canadian market from the U.S., the report notes.
“Canadian policymakers have made significant structural changes to the market — some informed by the U.S. example — that would help contain the effects that a severe housing shock could have on the country’s banks,” says Jason Mercer, assistant vice president at Moody’s, in a statement.
Roughly half of Canada’s fast-rising mortgage debt, amounting to nearly $700 billion, is explicitly supported by the Canadian government, according to the report. These backstopped loans have historically been high quality, the report says, “as stable employment and historically low interest rates have helped to stabilize servicing costs relative to disposable income. Further, legally mandated minimum down payments reduce the risk of collateral value declines.”
In its report, Moody’s simulates a historic-level mortgage crisis, including an overall house price depreciation of 25%, plus an additional 10% price decline in Ontario and British Columbia, which have seen prices rise most significantly over the past several years. In such a scenario, Moody’s estimates that the system could face losses of almost $18 billion.
However, the largest Canadian banks “would be able to absorb a major shock in the housing market without incurring catastrophic losses,” the report says.
Banks would be able to generate internal capital to cover losses within a few quarters, the report estimates. “While Royal Bank of Canada would suffer the largest absolute loss under Moody’s severe stress scenario,” the report says, “Canadian Imperial Bank of Commerce’s capital is most at risk owing to its operational focus on Canadian retail lending.”
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