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May 23, 2018 | What Could Go Wrong?

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Last year over 65% of the money the Big Maroon Bank with The Penguins made on all its retail operations came from – you guessed it – mortgages. But this spring there’s a been a deep, almost shocking, reversal. Listen to what Christina Kramer, head of CIBC’s retail banking, told analysts on a conference call Wednesday:

“We expect there to be an origination decline in the 50 per cent range relative to the same period last year. A year ago, two-thirds of our revenue would be related to our mortgage business and today that’s about a quarter.”

The ‘origination decline’ she’s talking about relates to mortgage volumes, as the bank expects the number of new home loans to plummet by 50%. That was enough to shove bank stock down 1.5%, but shares in CIBC (at $115) are still not far off their high of $123. Kramer’s colleagues were quick to point out that while the mortgage business sucks large right now, other things have perked up – like deposits. What a difference a little bit of extra interest makes, as the risk-averse and timorous listen to [email protected] and plow savings into those brain-dead GICs. It’s amazing how many people become aroused when they can make more than 2%.

So will housing whack the banks? Some people think so. The Big Short guy made some headlines the other day telling investors Canadian financial institutions were ripe for a tumble as the real estate market continues to wobble and possibly fall over. This is a uniquely American view, and based on experience there. As you know, the yanks securitized dodgy mortgages, turning them into AAA-rated investment assets that Wall Street harpies sold to unsuspecting clients. (“Hey, they’re residential mortgages? What could possibly go wrong?”)

The US housing crisis turned quickly into a credit crisis as investment and retail banks swooned when a wave of mortgage defaults turned the blue-chip assets into dung. Wall Street institutions failed and Washington spent (literally) trillions trying to revive the economy and restore faith in the financial system.

So through that lens, Canada looks pretty bad right now. Households owe more money than the size of the entire economy (over $2.1 trillion), 60% of which is in the form of mortgages on houses that may have tripled in value in the past few years. Classic bubble, based on loose credit and cheap rates. Real estate has soared. Incomes have not. So debt has soaked up the difference.

Meanwhile we’ve allowed real estate and related activity to constitute almost a quarter of the whole economy, more than manufacturing and oil put together. With interest rates now rising and serious new credit controls reducing mortgage activity (as the CIBC just revealed), it appears Canada’s banks are sitting with massive exposure to an asset class that can only tumble.

But what about mortgage insurance? Doesn’t Canada has in place a regime that will instantly protect the banks if homeowners started mailing back their keys? Yes, we do, and CHMC stands behind about $600 billion in mortgages. But that’s less than a third of the home loan debt outstanding, and does not take into consideration another $320 billion in HELOCs (40% of which aren’t being repaid).

More concerning is the whole reason we now have a stress test for new borrowers. Big numbers of moisters were getting around the old test in place for people with small down payments by scoring loans from the Bank of Mom. If they could plop down 20%, no test. So no mortgage insurance. No protection for the lender. And banks like CIBC found that while half their portfolios were uninsured, a large number of those borrowers might be sketchy. That’s why the bank regulator freaked, and now everybody has to prove their viability. Which is why mortgage borrowing just fell 50%.

Scary? Hmm, somewhat. Recall that when the credit crisis hit – created by the effects of American house lust – our bank stocks were mutilated. CIBC shares, for example, traveled from more than $100 down to about $40 – a collapse of 58%. Of course, during it all the bank continued to be profitable, and never cut its dividend payment to shareholders. This also proved to be one fat momma of an opportunity, since the bank’s stock has since risen by 175%. Those who know money is best made when the gutters flow red, cleaned up. Some things never change.

So this particular bank has over $200 billion in mortgages, which might concern you. But it also just announced an increase of 25% in quarterly profits, and is making money hand-over-fist. Like the other guys, Big Maroon has expanded its reach deep into the US, and reaps a harvest on everything from credit cards to insurance, wealth management to commercial banking and its retail deposit-taking, among other things. As I explained the other day, the banks want to now be seen as technology companies who have financial operations. Someday there will be no more CIBC branches, as credit replaces cash.

Sure, if this housing market thing comes unglued, investors might panic sell off the banks as they shed perceived risk. That could take much of Bay Street down with it (financials make up 34% of the equity market). In that case, back up the truck. I’ll drive.

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May 23rd, 2018

Posted In: The Greater Fool

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