MNI: BOC Sees Stress Emerging Among Indebted Households

Canada’s heavily indebted households are becoming a greater concern as the biggest jump in borrowing costs in decades create “some signs of financial stress” the central bank's annual Financial System Review found Thursday, suggesting damage may be well contained even with a majority of families due to renew loans at much higher rates and others having already negotiated easier repayment terms.

"While most households are proving resilient to increases in debt-servicing costs, early signs of financial stress are emerging," the Bank of Canada said. Two-thirds of mortgages have yet to refinance to reflect the Bank's rate hikes from a record low 0.25% to 4.5% over the year through January, and through 2026 the median mortgage payment will climb about 20%, the report showed. 

The report focused more concern on external forces such as a deep recession than domestic policies such as the Bank's low-for-long interest rates and Governor Tiff Macklem's pledge during the depths of Covid that Canadians could count on interest rates remaining near record lows for a long time given the expectation of a long and difficult economic recovery. Governments also enacted policies since the 2008 global financial crisis crashed the U.S. housing market to spur demand such as first-time homebuyer incentives even as Toronto and Vancouver prices skyrocketed past the million dollar mark in a nation where incomes are typically less than a tenth of that value. 

Private banks and the IMF warned Canada's housing market was one of the most overstretched in the world even before the rise in borrowing costs. Since then, Canadian regulators have emphasized lenders can take steps such as allowing borrowers who ended up devoting all their payments to interest to get relief such as taking on longer amortizations. 

"In light of higher borrowing costs, the Bank of Canada is more concerned than it was last year about the ability of households to service their debt. More
households are expected to face financial pressure in the coming years as their mortgages are renewed. The decline in house prices has also reduced homeowner equity, and some signs of financial stress—particularly among recent homebuyers—are beginning to appear," the report said. 

For example, the share of new mortgages with an amortization period longer than 25 years increased from 41% to 46% last year, the Bank said, up from 34% in 2019. The share of new mortgages with a debt service ratio exceeding 25% increased from 12% to 29% last year. Families that took out mortgages in the last few years are also taking on more credit-card debt.

"While increases in mortgage payments should be manageable for most households, the impact will be more significant for some. Federally regulated
financial institutions have stress-tested borrowers at higher interest rates since 2018, which means most households should have a buffer to support higher payments," the Bank said.

Domestic financial institutions have been resilient so far to the collapse of SVB and Credit Suisse but remain vulnerable to any prolonged or intense squeeze in wholesale funding markets and to any deep global recession, the Bank of Canada’s report said. Canadian banks rely more than global peers on on wholesale markets such as long-term debt and commercial paper and carry more loans and mortgages on their books than U.S. peers, the central bank said. Domestic banks on the other hand have only 2% of their assets in commercial real estate, an area of concern in the U.S. banking industry. 

"Canadian banks remain robust, but they are not immune to international developments," the Bank said. "As the financial sector adjusts to higher interest rates, participants, regulators and central banks must be more vigilant about vulnerabilities and risks." The report also identified risks from climate change, cyber attacks and crypto assets, and reiterated policy makers are prepared to provide emergency liquidity if needed.

The report didn't give an outlook for the policy interest rate, though Governor Macklem has a press conference later.