Canada: robust banks will weather mortgage storm

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Universal healthcare. Milk in a bag. Canada may be right next to the US. But the country differs from its southern neighbour in many ways, mortgages among them.

The sharp run-up in interest rates over the past 19 months has been painful for consumers on both sides of the border. Canadian homeowners have the added worry of a big jump in their mortgage payments next year.

In the US, the standard mortgage is a 30-year fixed-term loan. Canadians can rarely lock in rates for such a long period. Instead, Canada’s C$2.1tn ($1.5tn) mortgage market is made up of short-term fixed and variable-rate loans.

A common mortgage is a five-year fixed-rate mortgage amortising over 25 years. After five years, borrowers are exposed to any rate increases during the intervening period. 

Research from the Royal Bank of Canada shows that about C$900mn worth of mortgages — almost 60 per cent of all outstanding mortgages at chartered banks in Canada — will need to be refinanced between 2024 and 2026. 

Payments will soar if Canada’s central bank keeps its policy rates at 5 per cent. Rates for a three to five-year insured fixed mortgage have shot up from 1.93 per cent in November 2020 to 5.74 per cent in October 2023. 

Payment increases range from a weighted average of 32 per cent next year to 48 per cent in 2026, according to RBC.

For Canada’s Big Six banks, the biggest concern is mortgage defaults and losses. Bank of Montreal, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank already have $128bn worth of variable-rate mortgages that are in “negative amortisation”. This means interest charges exceed the regular payments of borrowers, adding to the principal.

The Big Six should be able to weather the storm. Unemployment has remained relatively stable. Credit quality is tolerable. 

Moreover, the threat of mortgage payment shock should prompt the central bank to start cutting rates sooner rather than later. Canadian retail and consumer stocks are in greater peril than bank shares.