The Bank of Canada has released its Financial System Review today and although no direct mention about the housing market was made, the BoC did warn about rising household debt, including mortgage debt (read entire report here)
The vulnerability of Canadian households to a deterioration in economic conditions has risen in recent years, as aggregate household debt has increased in relation to income.
There is thus a risk that a shock to economic conditions could be transmitted to the broader financial system through a deterioration in the quality of loans to households.
With the household debt-to-income ratio at historically high levels, this risk remains a key source of vulnerability.
The Bank has conducted a stress-test simulation to gauge financial stress in a scenario of sustained growth in household indebtedness in relation to income and an environment of rising interest rates over the medium term. This exercise underlines important risk-management challenges for individual households and financial institutions alike.
When borrowing funds, especially in the form of mortgages, households need to assess their ability to service these debt obligations over their entire maturity, taking into account likely changes in both income and interest rates and the risks surrounding this outlook. Financial institutions need to carefully consider the aggregate risk to their entire portfolio of household exposures when evaluating even an insured mortgage, since a household defaulting on an insured mortgage would likely be unable to meet its other debt obligations.
The Bank judges that the likelihood of system-wide stress arising from substantial loan losses on Canadian household portfolios remains relatively low at the moment, particularly given the near-term prospects for growth.
However, the likelihood of this risk materializing in the medium term is judged to have risen since June as a result of higher levels of household indebtedness.
Starting on pg. 28 of the report, a simulation is included to show how the share of households with a high debt-service ratio would rise when borrowing costs go up after mid-2010.
According to the bank’s exercise, the share of households with a debt-service ratio higher than 40% of income would rise to 8.5% by the second quarter of 2012, assuming the central bank’s rate is 3.2%, and to 9.6% assuming the central bank’s rate is 4.5%.
In comparison, households with more than 40% debt-service costs was 6.1% over the past decade and a record of 7.4% in 2000.
Orphaned Homeowners
Poor debt-service & LTV ratios lead to other problems. In the Globe & Mail article entitled “Orphaned Homeowners Face Foreclosure“, you’ll see how some homeowners will be unable to renew their mortgages even though they haven’t missed a single payment.
Ivan Wahl, Xceed’s CEO, said his company has identified 1,100 borrowers that his company will maroon over the next three years. But that is just Xceed.
Under records obtained under the Access to Information Act show that a lobby group representing these lenders has warned the federal government that, unless taxpayers offer help, they will be forced to foreclose on as many as 30,000 homeowners over the next three years.
BoC Governer has asked for “prudence” from Canadians. But how is prudence of any value when homeowners making their mortgage payments on time are now facing foreclosure? These predatory lenders have enticed buyers that wouldn’t have normally qualified, made their profit (interest rates hovered as high as 11%!), and are now asking for a bailout. Prudence, indeed.
