Mortgage Growth Buckles Under Weight of Rate Hikes in Canada

The aggressive pace of interest-rate hikes is hitting mortgage books at Canada’s biggest banks, leading to slowing loan growth, longer amortization periods and a rise in impairments.

(Bloomberg) — The aggressive pace of interest-rate hikes is hitting mortgage books at Canada’s biggest banks, leading to slowing loan growth, longer amortization periods and a rise in impairments.

Higher borrowing costs cut into mortgage growth, with would-be homebuyers sitting on the sidelines. At the country’s five largest lenders, including Royal Bank of Canada and Toronto-Dominion Bank, residential loan growth slowed to 4% in the fiscal third quarter, compared with annual growth of 9.8% a year earlier.

Meanwhile, the amount of impaired loans in the five firms’ core Canadian banking businesses almost doubled from a year earlier. Stage 3 loans — an accounting category for loans in default that are less likely to be paid back — ballooned to nearly C$1.3 billion ($960 million) in the three months through July from C$717 million a year earlier.

Royal Bank and Toronto-Dominion had the largest Stage 3 totals, at C$302 million and C$285 million, respectively, reflecting the bigger loan books at the two banking giants. Still, the figures account for a small fraction of the lenders’ overall portfolios.

Bank of Nova Scotia said it’s been deliberately slowing mortgage growth as it shifts use of capital.

“We’re just being more disciplined with regards to customer selection at time of origination, and this is a good time to drive that standard higher here because it’s a softer, slower housing market,” Dan Rees, Scotiabank’s head of Canadian banking, said on a conference call this week. “We are also being more efficient with regards to our use of capital and using customer deselection at renewal as part of that conversation.”

The strategy has been improving Scotiabank’s net interest margin, or the difference between what a bank earns on loans and what it pays for funding, over the past two quarters, said National Bank of Canada analyst Gabriel Dechaine. Mortgage balances have declined about 2% in its Canadian division since the beginning of the year, he said.

The timing of the pullback is ideal since mortgage spreads have been tight in recent quarters, Dechaine said in a note to clients, and investors may welcome lessened exposure to the residential-loan market as risks rise.

Other banks have taken different approaches to mortgage risks. Some are reaching out to borrowers who’ve hit their trigger rates — the point where they’re paying only interest, and aren’t making progress on their loan’s principal. Banks are proposing solutions such as lump-sum payments, fixed-rate mortgage options or extending the mortgage’s amortization to keep monthly payments from rising too much.

The last option has been popular with Toronto-Dominion and Royal Bank clients, boosting the share of mortgages with amortizations of more than 25 years.

In the third quarter, 43% of Royal Bank’s Canadian residential loans had amortization periods exceeding 25 years, up from 40% a year earlier and 26% in January 2022, before the Bank of Canada began its rate hikes. At Toronto-Dominion, the share of over-25-year amortizations rose to 48% from 35% a year earlier, and at Canadian Imperial Bank of Commerce the portion grew to 47% from 43%.  

Perhaps more concerning for CIBC is the C$37 billion of Canadian mortgages on its books that are set to renew in 12 months, C$7 billion of which are variable. As borrowing costs rise, variable-rate mortgages are impacted, with the bank offering to extend amortizations to borrowers who need it until renewal, CIBC said in an investor presentation Thursday. Once a mortgage is renewed, it reverts back to its original term schedule, which may require additional payments.

“Proactive outreach included a number of programs and initiatives throughout the year to help our clients through a rising rate environment,” CIBC said in the presentation.

Read More: Homeowner Stress Bursts Into View in Canada Banks’ Mortgage Data

The Bank of Canada began its recent rate-hiking campaign in March 2022, raising its trend-setting policy rate from 0.25% to, most recently, 5%, the highest in 22 years. Canadian lenders raised the prime rates they charge Canadian consumers in tandem, leading to the highest mortgage costs in years.

–With assistance from Doug Alexander.

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