What Does the Bank of Canada Know That We Don’t?

By Christine HughesCanada. Chief Investment Strategist, OtterWood Capital:

In a totally unexpected move, the Bank of Canada cut the overnight interest rate by 25 basis points on Wednesday. This of course makes me wonder what the Bank of Canada knows that the rest of us don’t! I mean usually the Bank indicates a bias towards cutting interest rates, but this was just out of the blue. It signals that the oil shock on the economy is going to be a lot more significant than anyone expected.

The Canadian dollar dropped vs. the US dollar thanks to the surprise move. Gold and silver prices climbed on safe-haven demand. Canadian bond yields plunged. As per Bloomberg: “’It’s a big shock,’ David Doyle, a strategist at Macquarie Capital Markets, said by phone from Toronto. “They’re going to try to provide the necessary medicine here for the soft landing from slowing debt growth, from slowing investment in the oil sands, and I think they thought it needed some stimulus here.”

No one probably stands to hurt more from plunging oil prices than Alberta.

Energy companies have started cutting capital expenditure, and this means job losses, which means a slowing housing market. In fact, plunging oil prices have seen home sales in Calgary tumble 37% in the first half of January, compared to a year earlier. Prices dropped 1.5%. And active listings soared by nearly 65%.

As you can see in the chart below, while you may have thought Toronto was a hot housing market these past several years, you’d be wrong. It was Calgary.
What’s the most worrisome about this is that everyone thinks Canada’s mortgages are different than what caused the US housing market to blow up. Well, not exactly. See, mortgage standards vary by province, and things in Alberta don’t look good.

There are two types of mortgages Alberta can issue: recourse and non-recourse. In a recourse mortgage, the bank can cease your house, sell it, and you will still owe the remaining balance of your mortgage. In a non-recourse mortgage, the bank can seize your house, and you the borrower can walk away. If the asset doesn’t sell for at least what you owe, then the bank has to absorb the loss.

Below is a chart, courtesy of RBC Capital Markets, which outlines that 35% of all Alberta mortgages (by the big 6 banks) are non-recourse. They can walk away!  Pay attention to Royal Bank especially:
There’s definitely a reason why the Bank of Canada is very concerned! By Christine Hughes, OtterWood Capital

BHP Billiton, the largest miner in the world with big oil & gas interests in the US, explains – perhaps unwittingly – the irony: despite an oil glut, collapsed prices, and layoffs, US oil production will continue to soar. Read…  Why the Great American Oil Bust Will Be Long & Painful


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  10 comments for “What Does the Bank of Canada Know That We Don’t?

  1. jeb
    Jan 22, 2015 at 10:23 pm

    I manage my mother’s investment portfolio (she is in her eighties) and a year or two back, I decided it was time to try and protect her assets as much as possible… given that the Canadian finance minister (The Late Jim Flaherty) announced that “Bail-ins” were part of the new fiscal plan in Canada.

    When I went to mother’s bank (The Royal Bank of Canada), sure enough, we found that she had over $600,000 of assets all allocated to one bank, while CDIC insurance in Canada only covers her for $150,000 in the event of a banking default. (CDIC in Canada = FDIC in America).

    The bankers went into default mode and pulled out the guns, even for me suggesting that her deposists weren’t safe.

    “Oh no!” They declared, “Didn’t you see how well we did after 2008? Canadian Banks are secure! We are far too regulated to let that kind of stuff happen!”

    “Didn’t you see that the Bank of Montreal lost over 60% of its market cap during the financial crash?” I asked.

    “Yes,” the smarmy investment manager replied, “They were far too exposed to the United States during that time.”

    “And you are not?” I asked.

    “No,” she replied. “We have a feduciary responsiblity to inform our clients of the best possible financial routes.”

    “And yet,” I responded, “The Bank of Montreal did not do their feduciary responsibility by informing their clients of the full risks of their investments… which is why they endured a 60% haircut on their market cap.”

    “Yes,” the lady said, “They were far too exposed to US Debt.”

    “And you guys,” I asked, “This 2.25% you are paying on my mother’s $200,000 term deposit… that is higher than prime… so… I assume it is not in government bonds but rather in something paying a higher interest rate… which involves more risk. Plus… you must have to make some money on top of that return in order to, well, stay in business!”

    “Yes,” she replied to me. “We pay that percent interest because it is backed by our own mortgage portfolio, as well as lending for things such as infrastructure.”

    ‘So…” I asked her, “If interest rates returned to 7% and caused house prices to fall by over 50%, this investment would be VOID!”
    “Well, that won’t happen,” she responded,” because Canada’s mortgage market is so well regulated.”

    “Uh huh…” I replied, “And yet the Bank of Montreal’s Market Cap dropped by 60% during the financial crisis.”

    “Yes, they were too exposed to US Debt.”

    “And,” I added, “Aside from your own mortgage portfolio, my mom’s interest rates are protected by your financing of “infrastructure?”

    “Yes,” she replied.

    “Do you mean like the infrastructure financing made possible by Public Private Enterprise… you know, the kind that Detroit just defaulted on?”

    I mean… come on!

  2. mick
    Jan 23, 2015 at 12:08 am

    Royal bank is a fantastic short opportunity, and happens to offer the most liquid options of any Canadian bank. In fact, their options are the most liquid of any Canadian play, even the stock market.

  3. Paulo
    Jan 23, 2015 at 7:52 am

    This article reinforces why I switched to a local Credit Union many years ago for banking services. It also reminds me why we lived under our means and paid off home and property many years ago, despite only making a modest income. I now have been told by my Oil Sands electrician son, “you were right, Dad. These jobs don’t last forever. My friends thought I was nuts when I left working in Ft Mac 6 months ago. If things get worse I can always make my mortgage payment, no matter what happens”.

    If you drive through a Calgary or Ft Mac subdivision you see toys…..sleds, quads, trailers, motorcycles, massive trucks to haul them, over-sized homes with big screens in the front room, and know that nothing is paid for.

    Ignorance was bliss.

  4. Mark B
    Jan 23, 2015 at 5:16 pm

    Had a Canadian friend who worked with me for a number of years here in Oregon. We watched the mad run up in housing prices starting in 2003 and seemed to be the only two in our division that thought this didn’t make any sense. Boy were we ridiculed with variations on “its different this time” or “you just don’t understand what’s happening”. After the crash, he ended up moving back to Canada and we stayed in touch. He started seeing the same rise in housing prices there and told me he was getting exactly the same responses, even though he was pointing out what he had just *experienced* in the US.

    Instead of “its different this time”, he heard “its different here”. I.e. the Americans were stupid and greedy, our country is much better run; we know what we’re doing.

    People are people, nationalities don’t matter. We all have the same hardwired limitations: recentism, optimize bias, etc. etc.

  5. Larry
    Jan 24, 2015 at 5:59 pm

    At least one fact in the story is incorrect. Banks do not have to absorb losses from non-recourse loans. If the property sold doesn’t cover the mortgage, the lender can get a “deficiency” judgement from a court to recoup the difference.

    • Jan 24, 2015 at 7:08 pm

      They tried that in the full-recourse states in the US. Turns out, it’s nearly impossible to recover any significant amount of money from a homeowner who is upside-down (bankruptcy is also an option). And investors own their properties via LLCs for that very reason, and there is usually no cash in an LLC that is worth going after. Only relatively well-to-do people with good incomes and some unencumbered assets might be able to fork over some serious money. But they might not default on their homes.

      • Larry
        Jan 25, 2015 at 5:25 pm

        I live in one of those Prairie Provinces. All CMHC mortgages are automatically considered full recourse loans even if the borrower is from a non-recourse province. When I got my mortgage I put down 25% of the mortgage amount, which meant I did not need CMHC insurance. However, My bank (BMO) asked for a personal guarantee, which I gave since I had no intention of walking away from my home.

        In the last housing bust, banks did actually take borrowers to court. The author is simply incorrect when stating that banks “have no choice.”

  6. Dave
    Jan 24, 2015 at 6:47 pm

    This article is misleading, is that on purpose?

    The notes mention that (1) “Includes all prairie provinces”. AB and Sask then, or does this include MB too? We aren’t really looking at just Alberta in your numbers then for RY which you wanted us to pay the most attention to?

    Notes (2) and (3) point out that LTV for BMO and BNS were 55% and 58% respectively. So if I understand correctly these houses would need to drop over 40% in value before it even makes sense to “walk away” from the mortgage?

    What’s the LTV for uninsured mortgages at RBC?

    Talk about cherry picking stats for shock value.

    • Jan 24, 2015 at 7:19 pm

      You make a good point, Dave. However, in the run-up to the housing crisis in the US, homes were routinely over-valued by appraisers that worked for the banks. And banks touted these LTV ratios. This turned into a scandal. LTV ratios are only good if the “value” attached to the home is realistic. I don’t know how this works in Canada, but in the US that “value” just evaporated when it came in contact with the declining housing market.

  7. Dave
    Jan 24, 2015 at 6:57 pm

    Further, I think it is important to remember that 2 of the US states that got hit the hardest during the US housing crash, Florida and Nevada, are both full-recourse.

Comments are closed.