Upcoming Bank Loan Loss Provisions Won’t Be ‘Fireworks’, But Will Have a Lasting Impact

Analysts are expecting one of the strongest quarters in years. Bryden Teich, partner and portfolio manager at Avenue Investment Management, warns that the effects of the pandemic on banks’ loan loss provisions will not be a one-time blow to the financial sector, but will last much longer.

He said Yahoo Finance Canada he thinks that many “expect a lot of fireworks with this quarter, because it is the first quarter of the recession. I think this is going to have a very long tail.

That long tail, Teich said, comes in part from subsidies from banks, with mortgage deferrals being one of the biggest.

“You might not get the worst of it for three or six months in the future, because people will try to hang on for as long as they can, and a lot of that will certainly depend on how quickly the economy can get well.” and get people back to work.

According to Teich, accounting rules have also changed under the IFRS 9 expected loss impairment model, so that banks are required to report loan provisions and credit losses more quickly than there are a few. years. “Before, they could wait 90 or 120 days before starting to publish losses. These credit numbers need to be reported much quicker, so banks need to tell much quicker whether or not they expect delinquencies.

The magnitude of the loan losses will likely come from years when Canadians are dependent on debt, fueled by rising real estate values, allowing people to borrow against the value of their homes.

Loan amounts secured by residential real estate have soared since the early 2010s, peaking at $304.6 billion before leveling off as the pandemic approached. Teich said consumption fueled by home equity borrowing was displacing any real economic growth, describing years of stagnant GDP per capita and productivity.

“They feel richer, they take out a home equity line of credit, they take HELOC and they buy furniture or they go on a trip or they go out to dinner,” Teich said. “So with rising house prices, people will dip into their home equity and start using that money to consume in other parts of the economy.”

With rising home prices, many Canadians have taken advantage of loans secured by their home equity (like HELOCs). This has pushed many Canadians into deeper debt and increases the risks for households and banks in the event of mortgage deferrals and defaults.

The perceived wealth created by soaring house prices is being challenged by the impact of the pandemic on the economy, such as massive job losses pushing the unemployment rate to 13%, the second highest on record. As a result, many Canadian households struggled to pay off their mortgages and had to rely on mortgage deferrals from banks during this downturn. When Evan Siddall, CEO of Canada Mortgage and Housing Corporation (CMHC) addressed Parliament last week, he said that CMHC currently estimates that 12% of mortgage holders have chosen to defer their payments. The organization expects that by September, that figure will jump to 20%.

Arrears rates are also a concern for these agencies: CMHC expects a fifth of all mortgages to be in arrears if the economy does not recover sufficiently. In mid-May, the Bank of Canada released data showing that even with policy measures in place, the bank expects mortgage arrears to triple from 0.27% in Q3 2020 to 0.79 % in Q3 2021.

In 2009, these arrears reached 0.45%. All of these factors combined will create what Teich calls a “negative wealth effect” and lead to lower consumption as banks are overexposed to residential mortgages (taking up a large portion of the total amount of loans on all bank balance sheets, ranging from 28% to 61% in the first quarter of 2020).

Along with mortgages, corporate lending also poses a risk to banks that hold most of their loans in one or another sector.

“It’s definitely a double whammy,” Teich said. “Residential lending will be hit very hard, but commercial lending will be hit very hard as well.”

A spike in delinquencies and defaults in these two areas could affect their loan loss provisions more than in the last recession. “I think the longer term tail effect would be much worse than in 2008/2009,” he added.

Teich expects to see some banks perform better than others in the coming quarters. The two banks that Teich owns at Avenue Investment Management are TD and RBC.

“Traditionally they’ve both been very good on the lending side, they’ve been very good lenders, they’ve diversified their business,” Teich said. “We have continued to like these banks because we like the way they have performed over recent credit cycles.”

One bank that Teich sees as a risk in the current environment is CIBC. “CIBC has always had a reputation for not offering the best high quality loans and I think that’s the nature of some of their past cycles.”

Despite the market risks, Teich does not expect any dividend cut.

“I think all banks will do absolutely everything they can to not have to cut [dividends]because they realize how negative it will be to the feeling.

Much of the impact of the provisions on lending will depend on the economic recovery. Teich said what sets this financial downturn apart is how global it is. “It’s so wide. All the banks are going to have a hard time. I don’t think any of the banks will miss out or be spared in this.

Comments are closed.