The amount of debt on Canadian bank balance sheets tied to residential housing is staggering. Combine residential mortgages with home equity lines of credit, and the Big Six banks have just under $1-trillion worth of exposure to the housing market.
To the untrained eye, that sum can seem terrifying. Add the speculation about a housing bubble to the mix and you have to wonder: should we be worried?
It isn't an easy question to answer. As we learned from the U.S. housing crisis, whenever there's a real shock to the system – a Black Swan of sorts – historical models can be rendered useless, because everything becomes correlated in a downward spiral.
However, analyst John Reucassel at BMO Nesbitt Burns dissected the numbers, weighing each bank's mortgage exposure against the dynamics of the Canadian housing market and the impact of regulatory intervention. What he found is that the banks don't look to be in imminent danger.
No doubt, the $796-billion that the Big Six have lent out in the form of residential mortgages is hefty. But you have to break that figure down.
Of the total mortgage exposure, about 60 per cent is insured. (Good for the banks, not so good for Canada Mortgage and Housing Corp. and the private insurers.) 15 per cent of home equity lines are also insured. These loans amount to 29 per cent of the industry's total loan book, and they carry a risk-weighting close to 0 per cent, Mr. Reucassel noted.
As for uninsured lending, the loans in this group don't appear to be danger. Last quarter, the average loan-to-value on new uninsured mortgages was 64 to 72 per cent. For all uninsured mortgages, the average LTV is 53 per cent. Plus the federal government has clamped down on things like amortization periods, forcing Canadians to put more down if they want to bypass things mortgage insurance.
For reasons like these, the risk weightings on uninsured mortgages aren't astronomical, averaging 13.8 per cent for the Big Six banks. (Royal Bank of Canada is the exception, with an uninsured real estate secured lending risk weighting of 8.1 per cent.) OSFI also recently said that it is comfortable with these risk-weightings on insured mortgages.
However, Mr. Reucassel went so far as to calculate what a weighting hike would do to bank capital levels. If OSFI raised the risk weighting on insured real estate secured lending to 35 per cent, he found that it would increase the banks' total risk-weighted assets by $103-billion, pushing the Big Six's average common equity ratio to 8.5 per cent, from its current level of 9.1 per cent. 8.5 per cent is still above the mandated industry minimum.
"There are good reasons that uninsured [real estate secured lending] in Canada has relatively low risk weightings and even an immediate shift in risk-weightings would still leave Canadian banks well capitalized," he noted.
Taking it one step further, Mr. Reucassel also looked at the banks' exposures to the condo market – something regulators have hinted is the most vulnerable to a correction. What he found is that the Big Six's exposure to this market is "very manageable." The Big Six have $105-billion of loan exposures to condos, but only $5.3-billion is to developers. The vast majority is simply in the form of mortgages.
So nothing looks too scary for the banks. But even Mr. Reucassel adds a caveat. "To be clear, we are not suggesting that there are no credit risks in mortgage loans. Clearly, with high consumer leverage and home ownership rates above 70 per cent, there are risks. However, we believe the credit risks [to the banks] will be more closely related to unemployment or a rapid rise in interest rates (at least 300 basis points) than a house price correction."
Editor's note: The amount of residential mortgage lending by the big six banks has been corrected in the online version of this article.