A colleague, riding the bus to work one morning this week, heard two young men talking about a struggling friend whose bank significantly increased his mortgage payments due to Canada’s skyrocketing interest rates. Everyone is talking about this stuff.
With the possible exception of some of Canada’s biggest banks. They say their exposure to Canada’s residential real estate market is a matter we do not need to worry about. But in two cases, the numbers the banks provide are not enough to assuage our concerns.
The matter is not one of just good investor disclosure. Canadians’ ability to pay their mortgages on their absurdly expensive real estate is the existential question of the Canadian economy. As rates rise, borrowers of billions are getting squeezed. Can they cough up the money to pay off their loans, or are we on the brink of a wave of bankruptcies and falling real estate prices that will lead to a wider contagion? Every bit of data helps the public and policymakers assess the risks.
The bank that deserves credit for transparency in this matter is Canadian Imperial Bank of Commerce, which provided disclosure that earned them a story in The Globe and Mail last week. Based on a footnote in CIBC’s financial statements, The Globe reported that $52-billion worth of mortgages – about 20 per cent of CIBC’s $263-billion residential loan portfolio – were in a position where the borrower’s monthly payment was not enough to cover the entire interest portion of the loans.
Most big Canadian banks offer variable-rate mortgages with fixed monthly payments. When interest rates increase, more of the borrower’s monthly payment goes toward the interest portion. (Reminder, if you need it: Today, the Bank of Canada’s benchmark interest rate is 4.5 per cent, up from 0.25 per cent a year ago.)
Variable-rate mortgages with fixed payments can eventually reach a “trigger” rate, which varies by borrower. At that point, if borrowers don’t make higher monthly payments, they may not be reducing the size of their loans. CIBC, as well as Toronto-Dominion Bank and Bank of Montreal, offer mortgages that allow borrowers to maintain that fixed monthly payment, fail to cover the full amount of the interest and add the unpaid portion of the interest to the loan balance. It’s called “negative amortization.”
The big story is that CIBC’s disclosure is the first from a major bank outlining the amount of variable-rate loans in which payments no longer cover all their interest costs. The big question, however, is why TD and BMO have not disclosed it as well.
Certainly it’s not because borrowers are unaffected by the rising-rate environment. One sign, revealed in regulatory filings, is the proportion of residential mortgages with amortization periods longer than 30 years, which reveals the amount of mortgages that have been extended, giving borrowers more time to pay off their loans.
At CIBC that number reached 30 per cent at the end of January. But at BMO, it was even higher – 32.4 per cent. At TD, it was 29.3 per cent. At Royal Bank of Canada, which doesn’t allow negative amortizations but does allow the extension of the payback period, it was 25 per cent. (Bank of Nova Scotia adjusts the payments upward for rising interest rates, so there’s no trigger rate and no extended or negative amortizations.)
For the initial CIBC story, The Globe asked BMO and TD to match CIBC’s disclosure and explain why they would not provide the percentage or number of their mortgage loans with a negative amortization. In an absurdist theatre of many words, some more helpful than others, they declined.
BMO spokesperson Jeff Roman initially replied, “Reporting methodologies are in accordance with industry guidelines,” an answer that raises more questions, which I asked. Industry practice or industry guidelines? Who is offering these guidelines – bank regulators? Accounting standard-setters? An industry trade group? Does BMO think CIBC is out of line?
TD spokesperson Amy Thompson directed The Globe to Table 22 in the bank’s quarterly reporting, which she said included “available insights” on the bank’s mortgage portfolio. It did not include that data, so I asked if that meant, by definition, the insights we were looking for were not available.
I asked both BMO and TD: Does the bank believe the proportion of mortgage borrowers going into negative amortization territory is immaterial? Materiality is a concept of disclosure that is more than a quantitative size test. A fact is material if it can reasonably be expected to have a significant effect on how an investor prices a company’s stock.
Offered the opportunity to explicitly say the mortgage data was immaterial, BMO and TD failed. Mr. Roman replied to all my questions by saying that BMO’s “disclosures are prepared in accordance with [International Financial Reporting Standards] as well as requirements from securities and bank regulators.” And Ms. Thompson said, “TD complies with all securities laws and other applicable regulatory requirements,” while referring us back to Table 22.
Both banks deploy an analysis that presents the mortgage risk as very small. BMO, in an earnings presentation slide recommended by Mr. Roman in lieu of an answer to the question, says it has a residential real estate lending portfolio of $190-billion. Yet just 44 per cent is variable rate. Just $23-billion of that is renewing in the next 12 months, with 75 per cent of that uninsured by the federal government. Only $1.5-billion of that is held by borrowers with a credit score of less than 680. And of that, the amount with a loan-to-value ratio of more than 70 per cent is just $33-million.
See – tiny! Nothing to worry about. Trust us, no need for any additional data on borrower payment habits.
We have to assume from the lack of disclosure and the non-answers to my questions that TD and BMO do, indeed, view the proportion of borrowers going into negative-amortization status as immaterial. And considering TD and BMO have hundreds of billions in assets outside the Canadian residential market, and out of Canada entirely, they can certainly make that argument.
The issue, however, transcends a pure analysis of materiality in securities law. Certain investors may feel comfortable with the banks’ assurances, but more people than just the shareholder class will benefit from expanded disclosure. The preferred next step is for TD and BMO to start providing the information. It would be a shame, instead, if CIBC scaled back its disclosure and left us all wondering how Canadian borrowers are coping.
David Milstead