The Financial Post
One major factor behind Canadian banks being the envy of the financial world is that they get so much help from the federal government.
But there may be strings attached to that security — one analyst is predicting that the big banks could actually get hit with the bill in the unlikely event that Canada Mortgage and Housing Corp., which insures about $560-billion worth of the country’s mortgages, ever needs to be bailed out.
John Reucassel, an analyst at BMO Capital Markets, said in a recent note to clients that the banks could have to pitch in and support the agency that now supports them, in the event that the CMHC went bust.
“It appears to us that the CMHC is reasonably well capitalized and positioned to meet the challenges from a housing slowdown,” Mr. Reucassel said in his May 10 comment. “However, investors may be concerned that, in a severe downturn, Canadian banks may either a) need to recapitalize the CMHC; or b) absorb some of the losses.”
He prefaced his thoughts by noting that the banks are responsible players when it comes to mortgages and there are many checks and balances built in to the market aimed at weeding out risky borrowers. But the fact that Canadian consumers are sitting on record debt is a risk in itself, rendering them vulnerable to a potential rise in interest rates or unemployment.
How could it happen that banks are called upon to help the CMHC?
The banks are incredibly well protected. Let’s start with mortgages, the banks’ biggest single asset. Between them the big six have more than $960-billion of real estate related lending on their books, of which more than half is covered by default insurance issued by the CMHC, a government entity. The banks get paid, no matter what.
Now let’s turn to the other side of the balance sheet: Customer deposits. They’re guaranteed as well, by the Canada Deposit Insurance Corp. up to $100,000. So even if the institution has a reputation for taking risks, that won’t be a concern for millions of Canadians, because they know their money will be safe. True, lenders pay the premiums but as a Crown Corp., the CDIC is backstopped by — you guessed it — the taxpayer.
So unlike virtually every other business, big chunks of both the banks’ assets and their liabilities are guaranteed, protected from the risk that management might make a mistake.
Then of course there’s the promise of a government bailout if things go wrong for the banks. That support has always been expected but it became official earlier this year when the banking regulator designated all six lenders as “systemically important,” or too big to fail. To be fair, plenty of other countries have similar guarantees for their own too-big-to-fail lenders. But there are few places where the too-big-to-fail list encompasses virtually the entire banking industry, as it does here.
The banks have benefited handsomely from this arrangement, spinning off stellar earnings going back decades, but now some observers are starting to raise questions.
The main concern is around the impact of the CMHC. Critics worry that it’s massive presence in the mortgage market — roughly 62% of home loans in Canada are insured — has helped drive the recent run-up in prices. And given that the CMHC guarantee insulates banks from losses, some analysts say that it may have provided incentive to loosen up on credit standards. If that is indeed the case, then there is a risk that if the housing market goes into a serious correction, the CMHC could be overwhelmed by losses, leaving taxpayers on the hook.
For their part, the banks and the CMHC have always denied that such risks might exist, arguing that the government insurer is well capitalized with a stellar track record. But amid growing fears about not just the health of Canadian real estate but also the wider economy, both sides of the debate are beginning to look at what-if scenarios that might play out if housing goes into reverse and mortgage defaults start to pile up.
In a worst-case scenario, Mr. Reucassel’s argument goes, the government could require the banks to chip in and help out a battered CMHC through a tax or some other kind levy.
“In our view, if the CMHC requires recapitalization, then the banks would be subject to some manageable tax, or fee, over an extended time period to recapitalize the CMHC.”
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