Bringing it all back home Part 3

Part 3

Mortgage and Credit availability

Next we turn to the financial aspects of the housing markets. If borrowers are experiencing difficulties in meeting their monthly (or weekly) payments, normally they will approach the creditor and seek to negotiate a type of forbearance agreement.  This can take many forms such as extending the amortization period or increasing the principal of the loan through an equity take out in order to catch up with interest payments (to pay for daily expenses or to pay down more expensive debt such as credit cards).  As the following Chart shows, the chartered banks in Alberta have not slowed down their mortgage

bank-assets-ab_4112_image001granting appreciably in Alberta.  Mortgage loans have grown by about $15 billion in the past 18 months which would support prices for residential properties in Alberta.

Three of the Big Five report a breakdown in mortgage and business loans in Alberta (TD Bank and the Bank of Montreal do not). Scotiabank, Royal Bank and CIBC do not report their portfolios in a completely consistent manner. The Chart below shows the residential mortgage and the Home Equity Line of Credit (HELOC) portfolios of three major banks operating in Alberta. The principal difference between a regular mortgage and a HELOC is that the latter is also a credit facility which enables the mortgagor to draw up to a maximum amount (typically three-quarters of the assessed value of the mortgaged property) via the use of a chequing account tied to the HELOC.
bank-assets-ab_3548_image001

A major concern of the Canadian banks, and agencies which rate the banks’ debt, is the threat of widespread defaults in Alberta as happened during the 1980s. A proxy for the risk in a bank’s mortgage portfolio is the loan-to-value ratio (LTV) which is a ratio of the loan against the value of the real property. As principal is repaid, in the normal course, the LTV falls.  This predictability can be interrupted as we saw in the 2007-9 financial crisis when the received wisdom that real property always increased in value was shown to be sales management as opposed to sound finance and economics.  The lower the LTV the less risk the bank carries in the event of an unexpected decline in the value of real property.

For sophisticated Canadian banks with millions of customers, lending on real property has become less customer facing and more automated.  The Royal Bank, for example, uses an “automated valuation model” and appraisals when mortgage lending. This automated tool uses estimates of value by reference to “market data” that relies on sales of comparable property and “price trends.”  Drive-by appraisals may also be used.

According to the Bank of Nova Scotia’s annual report to shareholders: “Weak performance in the energy sector is also having a negative impact on Canadian tax revenues and has contributed to softness in Alberta’s housing market. The Bank has taken a number of actions to prudently manage loan exposures in this sector and in related consumer loan segments, and according to the Bank’s stress test scenarios, losses are expected to be manageable” (Scotiabank Annual Report 2016 at page 71). Scotiabank also reported that “retail delinquencies are tracking higher in Alberta. The outstanding loan exposures are primarily secured. The Bank continues to consider the impact of lower energy prices in its ongoing stress testing program. Results continue to be within our risk tolerance” (at page 78).

Likewise, the Bank of Montreal acknowledged “the consumer impact from higher unemployment, which will take longer to recover from and will continue to weigh on the province” (at page 56). In the Royal Bank’s report, a section entitled “forbearance” noted:

“We have specialized groups and formalized policies that direct the management of delinquent or defaulted borrowers. We strive to identify borrowers in financial difficulty early and modify their loan terms in order to maximize collection and to avoid foreclosure, repossession, or other legal remedies. In these circumstances, a borrower may be granted concessions that would not otherwise be considered. Examples of such concessions to retail borrowers may include rate reduction, principal forgiveness, and term extensions. Concessions to wholesale borrowers may include restructuring the agreements, modifying the original terms of the agreement and/or relaxation of covenants. For both retail and wholesale loans, the appropriate remediation techniques are based on the individual borrower’s situation, the bank’s policy and the customer’s willingness and capacity to meet the new arrangement. During 2016, some concessions were made to clients affected by low oil prices, the associated slowdown in Alberta’s economy and the wildfires in Fort McMurray; however, the overall impact of these concessions on our financial results was minimal” (at pages 57-58).

bank-assets-ab_16477_image001

TD in commenting on the bank’s exposure to the oil and gas sector as a whole noted:

“TD had $62.8 billion of consumer and small business outstanding exposure in Alberta, Saskatchewan, and Newfoundland and Labrador as at October 31, 2016, the regions most impacted by lower oil prices. Excluding real estate secured lending, consumer and small business banking drawn exposure represents 2% of the Bank’s total gross loans and acceptances outstanding. The Bank regularly conducts stress testing on its credit portfolios in light of current market conditions. The Bank’s portfolios continue to perform within expectations given the current level and near term outlook for commodity prices in this sector” (at page 30 of the bank’s fourth quarter Management Discussion and Analysis).

In the case of Alberta Treasury Branches, its residential mortgage portfolio has grown from $12.3 billion in June 2013 to $14.7 billion on September 2016.  ATB also participates in CMHC’s mortgage securitization program. At 30 September 2016 $5.33 billion were pledged as collateral to CMHC up from $4.77 billion at 31 March 2016,up from $2.64 billion at 30 June 2014 a doubling in just two years. [1]

Under the ATB Regulation, ATB has the power to enter into credit default swaps with a view to  hedging its geographical credit concentration.  This provision was put in place in 2004.  Section 10.2.3 of the Regulation reads:

“Notwithstanding subsection (1), ATB may enter into credit derivative contracts with financial institutions in Canada that have at least one of the credit ratings referred to in the guidelines referred to in subsection (3) in respect of residential mortgage loans secured by land situated in Canada for the purpose of diversifying
its geographic concentration risk.”

It is not clear that ATB has availed itself of this capacity during the recent downturn or whether management attempted to avail itself of these risk management techniques, but  determined the cost to be prohibitive. (A word search of “credit default swaps” turned up only a reference to the restructured ABCP holdings not residential mortgages.)

Turning to loans past due reported over the last 11 quarters (chart below), we see that arrears are growing and more steadily up to one month and over two months. The total amount reported has almost doubled in nearly three years which is hardly surprising. bank-assets-ab_3674_image001

The other large Alberta based financial institution engaged in residential mortgage lending is SERVUS Credit Union. The chart below illustrates SERVUS’s experience with loan payments past due over that past eight quarters.  Like ATB, SERVUS is seeing more payment arrears which have increased by 64 per cent over the past two years.

bank-assets-ab_26759_image001

Finally, in early December a report by Equifax Canada on Canadian consumer credit trends observed  “Compared to a year ago, the highest delinquency rate increases in the country were found in Alberta, Saskatchewan, and Newfoundland….What we are seeing in Western Canada and Newfoundland would be of more concern if people in the two regions hit hard by the oil bust were also piling on a lot more debt and they are not, especially in Alberta and Saskatchewan.”  The agency reported that the average delinquency rate in Alberta (excluding mortgage debt) had jumped from 1.07 per cent to 1.47 per cent in the third quarter of 2016. Alberta residents continue to hold the highest average level of non-mortgage debt at $27,956   or 1.7 per cent higher than last year.

The recent Transunion report also shows that for non-mortgage debt, delinquency rates are rising. Alberta’s current rate of 3.13 per cent is by far the highest in the country.         bank-assets-ab_6708_image001

Opinion

In summary, the banking industry continues to lend on the security of real property in Alberta. There is some evidence that individuals are less able to service debt and we are seeing more loans past due. The quotations taken from bank reports might be skeptically regarded as “bank speak” suggesting that everything is under control. Given the continuing challenges facing the provincial economy, it is probable that that banks and provincial lending institutions will be facing the dilemma of acting now before property values plummet to sell foreclosed properties or delaying with the prospect of an avalanche of distressed properties coming on to the market.

Footnotes

[1] ATB has also securitized some of its credit card receivables.  Such transactions provide ATB with a source of liquidity in an environment where deposit-raising has become more difficult for the Crown agent.

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