Wednesday, May 25, 2011

Canadian Banks' Exposure to Uninsured Loans Going Into Distress

Very rough calculation to follow.

Let's assume a worst case 33% drop in prices. Based on the CAAMP survey, roughly 20% of all mortgages have between 20% and 40% equity. (20% is of course the bottom end as anything less is required to be insured and I'm using 40% as the top end to account for transaction costs, which the bank must assume to foreclose and offload the house.) Assuming valuations are flat across equity that's $200 billion in mortgages. I expect that's a little low, given that recent purchases are more expensive and are more likely to have less equity and as well due to HELOCs some houses with less than 20% equity are uninsured too, but let's use that number for now. Roughly half of all mortgages are insured. That leaves us with $100 billion in uninsured mortgages in this borderline equity range.

Let's assume a horrific worst case of 40% of these uninsured mortgages going bust. The banks would face about a 14% loss on average for a total loss of $5.7 billion. That's about 3 quarters worth of profit for the big banks combined. Assuming their profits hold steady, that is.


jesse said...

I've done similar calculations to CMHC's exposure. Very roughly, a 30% drop in prices and a high default rate would mean a bailout approaching $70BB (yes billion). Most of that will be repaid; I figure the net exposure is on the order of $10-20BB taxpayer money over about 10 years, and some of that was retained earnings paid as dividends to the government (CMHC's shareholder). Yes a $10-20BB net loss sucks but it's not the end of the universe either.

For the most part, Canadians with high ratio mortgages have funded their own demise through mortgage insurance premiums, as they should.

GG said...

Yes, none of these numbers seem backbreaking for the country. They may hit the banks' stock price however. Part of my exercise was in consideration of a short bet.

If there was a Canadian bank short etf, I'd be all over it like a bad cold.

jesse said...

The problem with short ETFs is that they're often synthetic shorts (like SKF), so they revert to zero value in the long run. Good play if you know the timing, otherwise it's a millstone.