By Nichola Saminather
TORONTO (Reuters) - Canada's top six banks have deferred mortgage repayments at nearly double the rate of their U.S. counterparts, setting themselves up for a tough slog to return to their pre-pandemic performance as higher household debt and insolvencies weigh on borrowing.
Even with about 16% of Canadian banks' mortgage books subject to deferrals https://tmsnrt.rs/3h42quj, many investors believe the C$11 billion ($8.2 billion) that lenders have set aside to cover potential loan losses are conservative, based on current economic assumptions.
(GRAPHIC - Canada mortgage deferrals: https://fingfx.thomsonreuters.com/gfx/editorcharts/oakveqjwyvr/eikon.png)
They are concerned, however, that elevated unemployment and an expected souring of many deferred mortgages currently marked as performing loans will cap future lending and hurt earnings growth in the next few years.
"There's going to be limited earnings growth coming through, if any" until employment returns to about 80% to 90% of pre-coronavirus levels, said Sadiq Adatia, chief investment officer at Sun Life Global Investments.
Canada last week posted a surprise jobs gain in May, but the unemployment rate rose to 13.7%, sharply higher than February's 5.6%.
Despite a nearly six-fold rise in provisions in the April quarter, capital ratios fell by less than 40 basis points from the previous three months, helped by regulators' treatment of deferred mortgages as performing loans.
That has diminished the risk of dividend cuts and capital increases, Adatia said.
Canadian banks provided six-month deferrals starting in mid-March to help tide customers over the economic crisis sparked by the COVID-19 pandemic. Come September, clients' balances will be adjusted to reflect the deferral amounts, which they will be required to pay over the course of their mortgage.
U.S. mortgage deferrals stood at 8.5% as of May 24, according to Mortgage Bankers' Association data, in part due to higher government unemployment benefits and additional stimulus payments regardless of employment status.
With Canada's household debt-to-GDP ratio rising to 101.3% in the fourth quarter of 2019, making it among the highest in the developed world, the Bank of Canada warned last month that stretched consumers could remain frugal when pandemic-driven shutdowns are relaxed. [https://
Consumer insolvencies, which had been growing at the fastest pace since the global financial crisis even before the COVID-19 outbreak, slowed in March. But Credit Suisse (SIX:CSGN) analyst Mike Rizvanovic attributed the declines exclusively to pandemic-driven shutdowns, and predicted a "sizeable backlog" will begin to show up from June.
"The significant deterioration in Canada's economy and labor market will drive insolvencies materially higher over the medium-term," weighing on banks' loan growth, he said in a note. Rizvanovic said bank earnings are unlikely to return to fiscal 2019 levels until 2023.
Greg Taylor, chief investment officer of Purpose Investments, said banks have made an assumption that the situation will rebound quite quickly.
If a recovery is slow to materialize and lenders extend deferrals, "they'd have no choice but to increase provisions," he added, which would erode earnings.