Memo 1: Q2 GDP numbers pave way for Bank of Canada rate hold
As reported by Statistics Canada, GDP was roughly flat in Q2 at -0.2%, following a 0.6% increase in the first three months of the year. The contraction is attributable to “continued declines in housing investment, smaller inventory accumulation, as well as slower international exports and household spending.”
The report reflects just how deeply rising interest rates have cut into real estate demand, with housing investment down -2.1%, its fifth quarterly decrease. New construction has dropped sharply by -8.2%.
“These declines coincided with higher borrowing costs and lower demand for mortgage funds, as the Bank of Canada continued their monetary tightening, raising the policy interest rate to 4.75% in the second quarter,” states StatCan’s report.
On a monthly basis, GDP contracted 0.2% in June, with preliminary numbers pointing to a similar dip to come in July, indicating a steady cooling; both services-producing industries (-0.2%) and goods-producing industries (-0.4%) contracted in June with 12 of 20 industrial sectors posting decreases, according to the data.
While analysts largely anticipated a weaker economic showing this month, the numbers come in below the Bank of Canada’s forecast of 1.5%, providing strong rationale for the central bank to lay off further rate increases, and setting the stage for a rate hold in its next announcement on September 6.
“We are sticking to our view that Canada will experience a mild contraction, and today's surprisingly soft Q2 obviously makes that outcome much more likely,” writes Douglas Porter, Chief Economist and Managing Director of Economics at BMO.
“The broad softening in the domestic economy will almost certainly move the BoC to the sidelines at next week's rate decision after back-to-back hikes. Between the half-point rise in the unemployment rate, the marked slowing in GDP, and some cooling in core inflation, it now looks like rate hikes are over and done. Now, the Bank of Canada just has to be patient as they wait for inflation to come their way—but that could take some time, especially with oil prices backing up again.”
Check out the best current mortgage rates
Memo 2: Extra-long amortizations now account for over 40% of big bank mortgage books
New disclosures from two of Canada’s largest banks shed new light on how rising mortgage rates are impacting borrowers, particularly the trend of dramatically increasing amortization periods to provide temporary payment relief.
Royal Bank of Canada says that as of July, 43% of the mortgages in its residential mortgage book now have an amortization exceeding 25 years. That’s an increase from 40% in 2022, and the 26% disclosed last January. Amortizations that exceed 35 years now make up 23%.
TD, meanwhile, reports that longer amortizations now make up 48% of its portfolio, up from 35% last year, and has experienced a considerable increase in amortizations extending beyond 35 years, at 22.8%
These latest numbers indicate extra-long amortizations have ballooned since last quarter, when similar regulatory filings indicated they accounted for 25 - 32% of all mortgages on the big bank books.
Increasing amortization periods has become one of the most common forms of aid lenders are offering beleaguered mortgage holders, particularly those who have variable rates and who are on a fixed payment schedule. As the Bank of Canada has hiked its benchmark Overnight Lending Rate a whopping 10 times between March 2022 and July 2023 – bringing it from a pandemic-era low of 0.25% to 5% today – monthly payments have drastically increased for this borrower group.
However, unlike variable-rate holders on an adjustable payment schedule, these borrowers haven’t seen their monthly payments increase; rather, less of their payment goes toward their principal debt amount, and more towards their interest charges. As a result, many of them have hit their trigger rate – the point at which none of their payment goes towards their principal mortgage debt.
As interest-only mortgages aren’t allowed in Canada, lenders have combatted this growing phenomenon by extending the overall amortization period, sometimes by decades. This lowers overall monthly interest and payments, but it also defers the rate pain to renewal time, when the borrower must then snap back to their original amortization schedule.
According to research from National Bank, a full eight out of 10 variable borrowers who took out new mortgages between 2020 and 2022 have encountered their trigger rate; a number that is anticipated to increase, should interest rates keep rising.
Memo 3: Banks are preparing for future bad loans
It appears Canada’s banks are gearing up for a long, cold recession; the latest Q3 earnings reports reveal that lenders across the board are squirreling away more cash to offset the potential impact of increased loan defaults.
Bank of Montreal is among those leading the way in terms of financial precautions, setting aside credit loss provisions of $492 million, an increase from $136 million compared to the same time period last year.
Meanwhile Scotiabank pulled aside a whopping $819 million in Q3, double the $412 million it accounted for last year.
These beefed-up risk coffers are partly in response to new requirements introduced in June from the federal banking regulator, which calls for Canada’s big six banks to maintain a buffer of 3.5% of “total risk-weighted assets”. OSFI increased this threshold – known as the Domestic Stability Buffer – by half a percent, in order to give banks “more capacity to respond to potential vulnerabilities and ensures more capital is available to continue lending and absorb losses in times of stress.” These include high household and corporate debt levels, rising levels of debt, as well as increased global unease regarding fiscal policy and rising interest rates.
However, they’re also a sign that lenders are anticipating more borrowers won’t be able to keep up with their debts in the near future. In an interview with the Toronto Star, Jim Stanford, economist and director at the Centre for Future Work, stated, “This is a big hit and a big sign of trouble in Canada’s economy. It reflects the unprecedented increase in interest payments by Canadians.”
His take is echoed by concerns authored by Desjardins economists, who called for a recession to commence by year-end in a recent Economic and Financial Outlook.
“Everything from international trade and housing to real GDP and core CPI inflation have started to trend lower, suggesting that rate hikes by the Bank of Canada are having their intended impact,” they write. “As a result, we continue to expect a recession to start before the end of 2023 and continue through the first half of 2024… This should prompt the Bank of Canada to ultimately begin cutting interest rates from their current level early next year, prompting a rebound in growth in the second half of 2024.”