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March 4, 2019

Paul Rocha

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Credit Concerns Surfacing Amongst Canadian Banks


Credit Concerns Amongst Canada's Big 5 Banks

Keep a close eye on the banks' Loan Loss Provisions

This weeks bank earnings reports werr full of surprises, and not the kind the jolly old guy dressed in red brings you in December. No, this weeks bank earning reports were more like the surprise you get after opening your bonus payslip and notice how little you actually get to keep.

The first set of surprises were the earnings misses by CIBC, Scotiabank, and TD Canada Trust. We saw CIBC report profit drop of 11%, TD and Bank of Montreal both reported profits, but both missed analyst expectations. Canada's smaller banks did not fair any better. National bank profit also increased but fell short of expectations. Laurentian Bank reported a big 32% drop in profits, while announcing a 10% reduction in it's workforce.

The second set of surprises from this Bank Earning Season, was the almost cross the board increase in Loan Loss Provisions, with only Bank of Montreal not increasing. And the increases aren't small either, CIBC increased by more than double, Scotiabank increased by 26.5%, TD increased by 23% and RBC by 54%. These are big numbers.

So what's so Concerning about these big increases in the Loan Loss Provisions?

Well, let's first look at what a Loan Loss Provision is. Essentially banks have to have a reserve for bad loans. Or in other words, they have to put money aside in case of mortgage defaults. Just like any financially prudent person would put a portion of the  income away for a rainy day. The concerning aspect with last weeks reports is the increase by which most banks increased the provisions for loan losses (mortgage default).  A substantial increase in loan loss provisions may be an indication that the banks foresee trouble ahead with respect to mortgage defaults.

As mortgage defaults increase the likelihood that some of the defaults eventually lead to
power-of-sales and consequently, have the potential of leading to bank losses. If the defaulted mortgages where high ratio mortgages (less-than 20% down-payment), than these would have been insured with either, CMHC, Genworth, or Canada Guaranty. Mortgage insurances protects the banks against losses resulting from mortgage defaults. So therefor, Canadian banks are really only unprotected against mortgage defaults with respect to uninsured mortgages or in-other-words mortgages with at-least 20% down-payment. 

Overview of Uninsured Real Estate Landing By The Big 5

Bank

total Real eState Secured Lending

Uninsured Lending
 ( $ )

uninsured Lending
 ( % )

Royal Bank

$308.5 billion

$205.6 billion

67%

TD Canada Trust

$281 billion

$185 billion

66%

Scotiabank

$238.9 Billion 

$145.2 billion

61%

Bank of Montreal

$140.3 billion

$92.18 billion

66%

CIBC

$223.2 billion

$148.9 billion

67%

Mortgage defaults increase as the Real Estate Markets softens

When we have a sellers real estate market the default rates on mortgages tend to be low. Which makes sense since people who are having issues paying their mortgage will sell their home before they get in trouble with the bank. On the other hand when the real estate market is soft or sellers market the default rate increases, as it takes much longer to sell. Homeowners in this market might not be able to sell before the banks take action or might not be able to sell for a high enough price to cover the mortgage in it's entirety.

So, are we looking at a US style bank crisis?

Probably not. While the increase in loan loss provisions by most of the Canadian banks in the 1st quarter of 2019 increased, it is far too early to read too much into these numbers. Many factors will ultimately decide the fate of the Canadian Real Estate and Mortgage markets, including job growth, future interest rate increases, and overall economic health. It is prudent however to keep a close eye on these numbers.

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