Canadian Banks Why US is Convinced of Bear Case Scenario $RY, $TD, $BMO, $BNS, $CM, $XLF, $XFN

Americans are convinced Canadian Banks will crash and burn just like the 2008 financial crisis. US investors look at the very high proportion of mortgage loans that Canadian Banks traditionally carry and they worry. They accentuate the feverish concern by noticing that the Canadian housing market seems overheated. End of analysis Canadian Banks are vulnerable shorts start licking their chops.

The US investor has gotten into trouble before by comparing the US economy to another economy and making one to one correlations. They forget that the Canadians never jumped on the sub prime junk mortgage bandwagon. They simply do not have swaths of suburban sub divisions without buyers. Yes Condos in Toronto and Montreal seem very expensive. But foreign demand is helping keep prices up. With free trade you can live in Canada and have access to the US market. that is not going away.

Many mortgages are insured by something called CMHC. (Canada Mortgage and Housing Corporation) The American investor mistakenly assumes CMHC is like Fannie Mae and Freddie Mac. Simply not true. Fannie Mae and Freddie Mac  were private vehicles which needed to be bailed out by Washington. CMHC is a direct entity owned by the Federal Government of Canada. Its guarantees and obligations are rated the same as sovereign debt issued by the Government of Canada. Last time I checked Canadian Bonds are rated AAA.  Back that up with the very high probability that the federal deficit will be wiped out within the next year or so makes the Canadian covenant very strong. From the bank shareholder perspective a CMHC insured mortgage is very solid.

Continuing one step further the US economy had a big debate about too big to fail and are trying to mitigate the risk with unimpressive results to date. In Canada it is an open secret that if one of the Big Five were to teeter there would be help. Careers would end of course but the depositor and the economy in general would be protected. Also it is much easier to regulate five players than the thousands in the US market. There may be some intense back room discussions but in the end the Federal Government in Canada has moral suasion which will be respected by the banks. They just wouldn`t dare do otherwise.

So the structural risks the US economy experienced are not baked into the Canadian banking system.

Here is the problem.

Rising Interest Rates

Rates have no where else to go but up. Many mortgage borrowers cannot absorb a three percent increase in carrying costs. This is the Black Swan event that is waiting to glide into not only the Canadian Mortgage Market but Global Markets. You then need to parse the analysis regionally. Canada is resource rich including the all important category of oil and gas. Commodity reliant regions will do well and employment levels will stay up. Ontario particularly Toronto and the auto industry reliant South-West are vulnerable to exchange rate driven industrial downturns. Most of the blood will be spilt in Ontario. The Maritime`s are relatively small and Quebec has had a terrible real estate market for decades. It is difficult to sell a house in Montreal. The price boom experienced in Vancouver, Calgary and Toronto did not occur to the same extent in Montreal. Housing is cheaper overall so the numbers will be proportionately smaller.

So US Hedge Fund trying to short Canadian Banks will be disappointed because the sky did not fall US Style. When interest rates start to rise the impact on Canadians and US home owners will be the same. Not all boats will float. But relatively speaking there will be no difference between Canadian or US mortgage lenders attributable to rising interest rates.

George Gutowski,

Financial Skeptic Perpetually Looking for Black Swan