Household debt driven by mortgage credit expansion in the Canadian market is the main threat to the credit risk profiles of Canadian financial institutions, according to a new report from Fitch Ratings.
Low interest rate levels and a favorable economic environment have fueled the upward trend in Canadian house prices over the past 10 years, says Fitch Ratings, noting that house price increases have outpaced income, leading to record levels of household debt. Despite record-high debt-to-income ratios, persistently low interest rates have made an increased debt burden bearable by reducing households' debt service ratio – a situation that Fitch Ratings says will make Canadian households more vulnerable to adverse shocks.
As of Jan. 31, the six largest Canadian banks had $912 billion of exposure to the domestic residential mortgage market through $730 billion in residential mortgages and $182 billion in home equity lines of credit (HELOCs). Fitch Ratings used a single-factor stress test to assess the impact of a real estate shock on the banks – and, more broadly on the system – and forecasted cumulative gross losses ranging from $9.1 billion to $91.3 billion, depending on the magnitude of the stress. However, these stress test results declined in net losses of $4.1 billion to $41.5 billion after taking into account mortgage insurance provided by mortgage insurers owned or backed by the Canadian government.