March 17, 2023 | Canadian Banks are Different But Not Immune

Several banks made headlines this week. The Silicon Valley Bank of San Francisco was wound up after deposits fled. First Republic Bank, also of San Francisco, got into trouble and was rescued. Credit Suisse received government aid.

Are Canadian banks next?

These banks are in trouble for a variety of reasons but there’s a common thread. The rapid rise in interest rates, from about 1 percent to 5 percent in less than a year, contributed to the crisis. Silicon Valley Bank (SVB) had another problem caused by large deposits, in the billions of dollars, which management handled badly.

One investment that really hurt SVB was government bonds. These bonds should be a safe bet, but a 20-year bond yielding one percent at purchase will decline by 50% if rates rise to 5 percent in the first year. Nobody expected this.

Based in San Francisco, and closely connected to tech, and Napa Valley wineries, SVB ran a riskier business than a standard bank. But if SVB had invested that influx of deposits in T-bills they wouldn’t have gone under because of bad investments.

Other banks like First Republic Bank (FRC) also saw share prices plummet. A few days after SVB failed a consortium of 11 large US banks agreed to lend $30 billion to FRC as deposits. In a joint statement authorities praised that rescue:

“US Treasury secretary Janet Yellen, Federal Reserve chair Jay Powell and senior regulators said: “This show of support by a group of large banks is most welcome and demonstrates the resilience of the banking system.”

But a “resilient” banking system wouldn’t need rescuing, only 14 years after the 2009 debacle. And shifting risk to a consortium of banks does not lower the overall risk.

Canadian banks run a different business, focusing on retail lending to households with mortgages, lines of credits, car loans, credit and debit cards etc. All Canadian banks lend to businesses, but often those loans are backed by real estate, except for their largest customers.

The risk for Canadian banks is that heavily indebted households are unable repay their loans. This risk is also connected to rising interest rates, especially on variable rate mortgages which were very popular recently.

In early March 2023 regulatory filings showed that a significant number of mortgage borrowers were extending their mortgage amortization to 30 or even 35 years and beyond as of January 31, 2023.

Some banks allow borrowers to add unpaid interest to principal, usually on variable rate mortgages that were taken out when rates were 1.5 percent.

In a Globe and Mail article March 11, David Milstead reported that a significant portion of mortgages have amortizations longer than 30 years. On January 31 BMO was at 32.4%, CIBC 30%, TD 29.3% and RBC 25%.

If house prices decline further, or interest rates rise, more homeowners will get into trouble, triggering a crisis.

If that occurs, the Canadian government will fully backstop the banks in order to avoid a debacle like SVB.

Hilliard MacBeth

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Hilliard MacBeth March 17th, 2023

Posted In: Hilliard's Weekend Notebook

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