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Canadian Banks Get Case of HELOC Indigestion

In the midst of earnings season for the Big Five banks, a storm cloud is brewing that could put a damper on rising bank-stock prices.

Simply put, home equity lines of credit (HELOC’s) could be their undoing in the weeks ahead despite the good news we’ll hear over the next week.

Here’s why…

Rising interest rates a double-edged sword

We’ve heard for a long time how rising interest rates will put more money in bankers’ pockets, as everything from credit cards to mortgages and all other loan products cost consumers more.

Fair enough. That’s Business 101.

A stronger economy should be able to support higher interest rates.

However, what happens when HELOCs as a percentage of consumer credit reaches levels not seen since 2009 when they accounted for 57% (they’re around 45% today) of the total?

“The sharp appreciation in home prices in Ontario and British Columbia fuelled by [very low interest rates] have undoubtedly encouraged some homeowners to tap into their home equity in order to support a spending binge,” National Bank chief economist Stefane Marion wrote in a client note.

Marion’s colleague economist Krishen Rangasamy added to the discussion August 22 suggesting that the short-term effect of this spending binge is to stimulate the economy temporarily; the long-term effect possibly causing consumer financial instability.

In the last 12 months, National Bank estimates that $20 billion in HELOCs have been added to the debt heap with three million Canadians racking up loans totalling close to $222 billion dollars or  $74,000 per HELOC.

Real estate experts suggest that parents are using the equity built up in their homes to take out HELOCs to provide their kids with the funds to make a downpayment on a home.

That’s great if Toronto and Vancouver home prices remain high but if they dip by 40% in real, inflation-adjusted terms as they did between 1989 and 1996, not only are the parents and kids going to have a problem, so too will the banks.

Big Five Canadian Banks – HELOCs and Residential Mortgages Outstanding – Q2 2017

Bank

HELOCs

Residential Mortgages

%

Royal Bank of Canada (TSX:RY)(NYSE:RY)

$45.0B

$259.9B

17.3%

Toronto-Dominion Bank (TSX:TD)(NYSE:TD)

$81.4B

$217.1B

37.5%

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS)

$19.5B

$228.3B

8.5%

Bank of Montreal (TSX:BMO)(NYSE:BMO)

$35.1B

$113.0B

31.1%

Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM)

$21.0B

$192.9B

10.9%

Source: Bank’s Q2 2017 reports

Which banks have the biggest problem?

Well, I’m not an underwriting specialist, but from where I sit, if things get ugly, Bank of Montreal and TD appear to hold the greatest exposure to HELOCs.

Invest accordingly.

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