BNN Bloomberg | Mortgage renewals could cause severe downturn: analyst note

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Upcoming mortgage renewals at high interest rate levels will potentially drive the Canadian economy into a more severe downturn than anticipated, according to analysts at Keefe, Bruyette & Woods. 

In a note published Wednesday, analysts Mike Rizvanovic and Abhilash Shashidharan estimated the impact of Canadian mortgage renewals would total $34 billion by 2027, assuming all mortgages are renewed at currently elevated interest rate levels.

“The resulting hit to both consumer spending and economic growth would be meaningful, indicating that a 'higher rates for longer' theme could easily push Canada into a more severe recession than is currently expected,” the analysts wrote.

RATE PATH

The analysts said confidence among banks over the medium term “is largely predicated on the expectation that interest rates will decline.” 

“As such, we believe the trajectory of interest rates will remain a key focus for Canadian bank investors, with most remaining underweight the sector until there is more certainty that rates will in fact decline before too long,” the analysts said. 

Despite a series of interest rates from the Bank of Canada since last year that have brought the bank’s key rate to five per cent, the analysts noted that the “majority of homeowners” haven’t yet felt the impact of higher mortgage costs. 

The Bank of Canada has not indicated when it intends to cut interest rates, but the analysts with the investment banking firm made the case that rate reductions would blunt the economic impact of high-rate mortgage renewals.

The analysts estimated that a 100-basis-point reduction in interest rates would bring the $34-billion impact down to about $23 billion, showing that interest rates would have to fall significantly to “fully eliminate higher mortgage renewals.”

“Other potential mitigating factors include higher wage inflation and deposit rates, both of which are likely to remain elevated if inflation and rates remain higher, as well as forbearance by the banks (i.e. allowing borrowers to renew loans with a longer amortization period),” the analysts said. 

Currently, three major banks in Canada allow for negative amortizations in variable rate mortgage products, the analysts highlighted, including Bank of Montreal, Canadian Imperial Bank of Commerce and TD Bank.   

The analysts said balances for negative amortizations in variable rate mortgage products are $33 billion for the Bank of Montreal, $50 billion for CIBC and $46 billion for TD Bank.    

Meanwhile, Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, said it’s concerned about instances of long-extended mortgages and is working with lenders to rein in this type of borrowing.