Increasing house prices, particularly in Toronto and Vancouver, represent risks to the big banks, warns Toronto-based DBRS Ltd. in report published on Thursday.
Although the credit rating agency views the banks’ current mortgage exposure as manageable, rapidly increasing house prices in the Greater Toronto Area (GTA) and the Greater Vancouver Area (GVA), “pose a rising risk of deterioration in mortgage performance” for the big six Canadian banks, the DBRS report says.
“Currently, the banks’ exposures appear manageable,” the report adds. “A slowdown in the economy accompanied by a rise in unemployment could lead to a deterioration in mortgage performance and increased credit costs for the banks.”
The report points to a number of factors that are driving the demand for housing, including population growth, low interest rates and the availability of mortgage financing, and demand from domestic and foreign buyers for housing as an investment. These factors, coupled with supply constraints, are driving prices higher, the report says.
Recently, policymakers have taken action to cool the hot housing market, and the report says DBRS expects to see a slowdown, as a result. “This slowdown could be exacerbated, if the new actions prove to be too constraining. Provided growth in income and population continues, however, a major downturn in the housing markets and continuing sizeable growth in home loans appears much less likely,” the report says.
A significant downturn would be more likely in the event of a negative shock to the overall economy, or to employment markets, the report notes. Additionally, rising interest rates “could also lead to a downturn in the housing markets and a slowdown in the economy,” the report says.
“At this time of low inflation, the worst case scenario for housing is increasing rates combined with rising unemployment. This scenario appears unlikely at this time,” the report says. “Nevertheless, housing markets and mortgage credit quality could weaken if external market forces drove up market rates, and resulted in a drop in housing demand and a downturn in housing activity.”
In the meantime, banks are taking their own actions to slow growth in their mortgage portfolios and tighten underwriting terms. In Ontario and British Columbia, “the banks are already reducing the loan-to-value (LTV) ratios of their newly originated uninsured mortgage loans and home equity lending (HELOCs),” the report says.
“These growing constraints may serve to slow the pace of house price appreciation and limit the downside from any reversal of these upward trends in house prices,” the report adds.
Moreover, banks have capacity to absorb higher provisioning rates, the report notes, adding that a large portion of their mortgages are insured, and that the uninsured portion carries relatively conservative LTV ratios.
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