Several banks made headlines this week. The Silicon Valley Bank of San Francisco was wound up after deposits fled. First Republic Bank, also of San Francisco, got into trouble and was rescued. Credit Suisse received government aid.
Are Canadian banks next?
These banks are in trouble for a variety of reasons but there’s a common thread. The rapid rise in interest rates, from about 1 percent to 5 percent in less than a year, contributed to the crisis. Silicon Valley Bank (SVB) had another problem caused by large deposits, in the billions of dollars, which management handled badly.
One investment that really hurt SVB was government bonds. These bonds should be a safe bet, but a 20-year bond yielding one percent at purchase will decline by 50% if rates rise to 5 percent in the first year. Nobody expected this.
Based in San Francisco, and closely connected to tech, and Napa Valley wineries, SVB ran a riskier business than a standard bank. But if SVB had invested that influx of deposits in T-bills they wouldn’t have gone under because of bad investments.
Other banks like First Republic Bank (FRC) also saw share prices plummet. A few days after SVB failed a consortium of 11 large US banks agreed to lend $30 billion to FRC as deposits. In a joint statement authorities praised that rescue:
“US Treasury secretary Janet Yellen, Federal Reserve chair Jay Powell and senior regulators said: “This show of support by a group of large banks is most welcome and demonstrates the resilience of the banking system.”
But a “resilient” banking system wouldn’t need rescuing, only 14 years after the 2009 debacle. And shifting risk to a consortium of banks does not lower the overall risk.
Canadian banks run a different business, focusing on retail lending to households with mortgages, lines of credits, car loans, credit and debit cards etc. All Canadian banks lend to businesses, but often those loans are backed by real estate, except for their largest customers.
The risk for Canadian banks is that heavily indebted households are unable repay their loans. This risk is also connected to rising interest rates, especially on variable rate mortgages which were very popular recently.
In early March 2023 regulatory filings showed that a significant number of mortgage borrowers were extending their mortgage amortization to 30 or even 35 years and beyond as of January 31, 2023.
Some banks allow borrowers to add unpaid interest to principal, usually on variable rate mortgages that were taken out when rates were 1.5 percent.
In a Globe and Mail article March 11, David Milstead reported that a significant portion of mortgages have amortizations longer than 30 years. On January 31 BMO was at 32.4%, CIBC 30%, TD 29.3% and RBC 25%.
If house prices decline further, or interest rates rise, more homeowners will get into trouble, triggering a crisis.
If that occurs, the Canadian government will fully backstop the banks in order to avoid a debacle like SVB.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson Wealth or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances.. Richardson Wealth is a member of Canadian Investor Protection Fund. Richardson Wealth is a trademark by its respective owners used under license by Richardson Wealth.