Home Capital risk contained, but ‘unsustainable’ housing market a primary concern: Poloz

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Breaking his silence on Home Capital, Bank of Canada Governor Stephen Poloz said the mortgage lender's problems are contained but the sharp rise in house prices and their potential effects on the financial system have emerged as a primary concern.

In a weekend interview on the sidelines of the Group of Seven meeting of finance ministers and central bankers in Bari, Italy, Mr. Poloz said the Bank of Canada sees no signs that Home Capital's rapid deterioration has triggered contagion.

"We'd be looking for signs that there are problems with the [financial] system as opposed to preoccupying ourselves with individual institutions," he said. "The question would be: What caused this? Is it something unique to the institution itself, or is it something in the system? … I think this situation [Home Capital] is pretty clear on that; it's idiosyncratic."

Investigation: Home Capital mortgage lender was mere hours away from collapse

At the Bari G7, Finance Minister Bill Morneau had a similar message, concluding that Home Capital's problems were not spreading to the financial system as a whole.

The Globe and Mail reported on Saturday that Home Capital came close to collapse in late April, as a run on deposits and vanishing capital threatened to close the lender's doors. The mortgage company was apparently spared from oblivion by an emergency, $2-billion private line of credit offered under punitive terms, including a 10-per-cent interest rate.

Mr. Poloz said that the Office of the Superintendent of Financial Institutions and the Canada Deposit Insurance Corp. are closely monitoring Home Capital while the Bank of Canada monitors the overall health of the financial system.

He would not say whether the Bank of Canada came close to offering emergency liquidity assistance (ELA) – a collateralized loan of last resort – to Home Capital or whether it might do so if Home Capital's private-sector funding proves insufficient to stabilize the company. "I won't comment on what our conversations have been [though] the Bank of Canada is always ready to use its tools."

He gave no hint that Home Capital might still request ELA, noting that "the private sector was able to create a solution for this firm, so that's good – the system in action."

Some analysts had encouraged the Bank of Canada to issue a statement to counter any concerns that Home Capital might be the start of a wider mortgage problem. Ben Tal, deputy chief economist at Canadian Imperial Bank of Commerce, last week said "it's clear that the Home Capital situation is not the ultimate test of Canadian housing. The situation is contained and the quality of the assets is solid. Any reference to that reality from the [central] bank will carry a lot of weight."

Mr. Poloz has in the recent past called the soaring property values in some Canadian cities, notably Vancouver and Toronto, "unsustainable" and said so again in Bari. But he did not predict a property collapse even though prices in Toronto climbed by 25 per cent or more in the last year and speculation was no doubt playing a role in the galloping increases.

Unsustainable, he said, "does not mean we're going to get a major retracement in prices. … It just means that they can't continue to go up at these rates. Often, when you have a truly unsustainable housing market, you will see very rapid price increases [and] very rapid credit growth. … But we don't see that in the credit side, so I do think a significant amount of this that is fundamental, but layered on top, is a speculative element."

Still, the Bank of Canada is concerned that a shock to the Canadian economy, such as a 2008-style deep recession or a steep rise in unemployment, could stress the financial system if it meant that over-leveraged Canadians suddenly would have trouble servicing their mortgage debt.

"Well, that's a topic quite high on our list, in fact it's at the top of our list at the FSR," he said, referring to the bank's twice-a-year Financial System Review, which tests the system's ability to absorb shocks. "The bank is on record for two or three years, talking about increased urgency around that risk to the system."

The bank's FRS statement from December noted that the ratio of debt to household disposable income climbed to almost 170 per cent last year from about 150 per cent in the latter part of the last decade.

Mr. Poloz said, "People who are unable to service their mortgages would put the banks' books at risk and give rise to a more manifested risk to the financial system."

But he pronounced the system strong, noting that the banking system carries high liquidity and capital levels and that mortgage rules for home buyers, which were already robust, are being tightened up. For instance, home buyers need at least a 20-per-cent down payment to obtain an uninsured mortgage. "The kinds of scenarios and tests that we run suggest we have a very resilient system," he said.