Canadian banks could survive a 25% house price decline, Moody's says

Canada's big banks would survive even a serious downturn in the housing market, but it could still cost them almost $12 billion, a new report from Moody's says.

Banking system would be fine even if Toronto and Vancouver see a crash, ratings agency says

The average price of a Canadian home was more than $500,000 last month, CREA says. (David Donnelly/CBC)

Canada's big banks would survive even a serious downturn in the housing market, but it could still cost them almost $12 billion, a new report from Moody's says.

In a report Monday, the ratings agency made some pessimistic assumptions about the health of the housing market and came to the conclusion that the country's biggest lenders would be more than able to withstand a decline of more than 25 per cent "without catastrophic losses" to their businesses.

Moody's came up with that conclusion after looking at what happened to U.S. lenders during the housing crash there that began in 2007, and extrapolating the data to Canada.

The worst-case scenario for Canadian housing, Moody's says, is about a 25 per cent decline in the average house price, which was at more than $500,000 last month according to the Canadian Real Estate Association.

The two hot markets of Toronto and Vancouver, meanwhile, were assumed to have declined even more, by 35 per cent, in Moody's thought exercise.

Should that happen, Canada's biggest banks would see losses of roughly $11.7 billion. At that level, "the majority of banks would be able to absorb losses within one quarter of earnings," Moody's wrote.

CMHC insurance a factor

While a loss of more than $10 billion for the six biggest banks alone is significant, Canada's banks would be better equipped to limit the damage of a housing slowdown of that size due in part to how the market is regulated in Canada.

The vast majority of mortgages in Canada are insured by the government-backstopped Canada Mortgage and Housing Corporation, which means the banks are insured if any loans they make with CMHC-insurance go sour. That wasn't the case in the U.S. at the time.

For its part, the CMHC could expect losses of almost $6 billion in the Moody's analysis, a large figure but one it would be able to financially handle. "The majority of Canada's mortgage insurance backstop, provided by CMHC, is resilient," Moody's said.

Another reason why Moody's thinks a housing market crash wouldn't be as devastating in Canada is because Canadian mortgages are of much higher quality than the U.S. ones were, and have a much lower rate of so-called "sub-prime" borrowers who don't qualify for conventional mortgages because of their credit history.

Currently, only about five per cent of Canadian mortgage applicants are subprime. At the peak, nearly a quarter of U.S. ones were.

Canadian banks also do a lot less securitization of mortgages in Canada, which is a process whereby the lender sells off the debt in smaller chunks and thus has the potential to spread the risk of default to new, unexpected places. 

Adding up those three factors leads Moody's to conclude that Canadian banks could survive even an unexpected and devastating body blow to the housing market. "We believe several structural characteristics of the Canadian mortgage market, as well as macroprudential adjustments made by Canadian regulators following the U.S. sub-prime crisis, would help Canadian banks to weather the effects of a major housing shock," Moody's said.