Be Careful One needs to recognize that banks are highly levered institutions , and CDN banks are some of the most highly levered in the world. Using US regulatory definitions of leverage, CDN banks hold $1 in equity for $24 in assets. What does this mean? If assets fall by 5 percent, it wipes out the equity. With so many of the assets at CDN banks tied into housing (but also to other areas, such as oil and gas), this is a monster risk not lost on bank execs or the government .
This crisis couldn’t have come at a worse time for Canada.
Canadian consumers are now using 15% of disposable income to repay the servicing on their debt, matching the 2009 recession peak. Household debt to disposable income reached 170 percent in the US in 2007/2008 prior to plummeting to 130 percent by 2016. Where are we in Canada ? 180 percent as of the end of 2019, in excess of where the US peaked. Let’s not even start with where the oil price is and how exposed cdn banks are to Alberta.
Don’t get me wrong , the CDN banks exposure to mortgages is somewhat backstopped by taxpayers , thru the CMHC. Because of this backdrop, CDN banks collude and aggressively issue mortgages, knowing they will be bailed out. Because of this security, they don’t need to keep much capital against insured mortgages , allowing them to juice returns.
This Ponzi scheme needs one thing to persist - house prices staying up. One of the reasons that we allow so many rich immigrants into the country - so they buy houses. And also why interest rates aren’t heading up anytime soon (which hurts the banks net interest margin, or NIM).
What if this orgy of leverage is at risk, due perhaps to an event like Coronavirus? The banks turn to the taxpayers of course .
Yep, late this week, the government expanded the program of buying bad mortgages from the banks to $150 billion for FACE VALUE. This was less than a week after reintroducing this program at just $50 billion (this was last used in 2007/2008). Just imagine how bad things are looking for them to triple this in a week. All those condo speculators mortgages issued by banks are being bailed out. This is outrageous , and just perpetuates our nutty housing market. https://www.ctvnews.ca/mobile/business/cmhc-expanding-insured-mortgage-purchase-program-to-150b-up-from-50b-1.4869563
But it also highlights the risk underlying our housing market. And taxpayers just bailed out the banks, albeit quietly in a way most Canadians won’t notice. Just another day in Canada.
So recognize that buying a cdn bank common shares is a bet that this merry go round on housing persists and overall loan books hold up. If this is a deep recession, the banks will be forced by the regulator to issue capital, diluting share holders . This drives down share prices.
Please don’t view these instruments as low risk.