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Canada’s Largest Bank Is Amongst First Victims Of Mortgage Debt Crisis (#GotBitcoin?)

Canada’s largest bank by assets is moving to protect itself as pain spreads through the mortgage market. Canada’s Largest Bank Is Amongst First Victims Of Mortgage Debt Crisis (#GotBitcoin?)

The Royal Bank of Canada RY 5.89% moved Wednesday to unload hundreds of millions of dollars worth of commercial real-estate debt seized from clients in recent days, trying to protect itself from pain spreading through the mortgage market.

RBC, Canada’s largest bank by assets, was seeking bids Wednesday for more than $600 million of debt tied to commercial mortgages, according to people familiar with the matter. In a sign of how quickly the market is deteriorating and the pressure institutions feel to quickly deal with the situation, the bank is expected to choose a buyer by the end of the day.

Mortgage bonds of all kinds have tumbled in value in recent weeks, even those that had top ratings from credit agencies. Investors are worried borrowers will default en masse as the economy slows to a halt.

That has prompted margin calls from banks that lend against these bonds. Borrowers can either try to sell the debt themselves at fire-sale prices or post more collateral to buy time—or the lender can seize the bonds and try to sell them itself.

That is what RBC is doing. Among the collateral the bank is auctioning are mortgages that had been owned by AG Mortgage Investment Trust, a real-estate investment trust operated by New York investment firm Angelo, Gordon & Co., one of the people said.

The RBC sale involves nearly $11 million of commercial mortgage bonds held by AG, the company said.

AG filed a lawsuit against RBC on Wednesday to stop the sale, accusing the bank of taking advantage of turmoil in the mortgage market to apply “opportunistic (and unfounded) markdowns” of mortgage assets to trigger margin calls and seize the collateral, according to the suit.

“Recognizing the aberrant state of the markets, most banks have stopped short of taking precipitous steps that could push the [mortgage REIT] industry into the abyss,” according to the suit, which calls RBC an “outlier bank…that has not stopped short but is instead hitting the accelerator.”

AG warned the move would “have a cascading effect in the market for mortgage-based assets, and potentially the entire U.S. economy.”

A spokesman for RBC declined to comment.

AG Mortgage said Monday it was having trouble meeting margin calls from its lenders, followed in short order by mortgage funds run by TPG, the private-equity giant Invesco Ltd. and others. Shares of these publicly listed funds and others have plummeted as the novel coronavirus has spread.

Some banks have discussed forbearance measures, which would give these mortgage investors time to improve their health.

RBC is opting not to wait. It is a sign that banks, despite being in far stronger shape than they were in the 2008 financial crisis, are warily watching their loan books for trouble signs. Companies are quickly tapping their credit lines, requiring banks to come up with billions of dollars of cash quickly. What’s more, rules put in place since the last downturn require banks to quickly refill depleted coffers.

Adding, perhaps temporarily, to the problem is that banks will close their quarterly books on March 31. Even in normal markets, banks typically try to pare risk ahead of a quarter-end by selling loans and shoring up their collateral.

Publicly traded U.S. companies have drawn down at least $100 billion from banks in recent weeks, according to S&P Global. Some private-equity firms have encouraged their own portfolio companies to do the same, putting additional strain on banks’ balance sheets.

Goldman Sachs Group Inc. analysts estimate that large, regional and trust banks have $2.6 trillion in unfunded commercial-loan commitments on their books, including half a trillion to companies in particularly hard-hit sectors such as energy, transportation and retail.

If those loans were entirely drawn, the biggest lenders’ capital ratios would fall below certain regulatory minimums, Goldman said, but added that any stress should be eased now that banks are able to more easily borrow directly from the Federal Reserve.

Josh Barber, an analyst at mutual fund Diamond Hill Capital Management in Columbus, Ohio, who focuses on real estate, said he expects banks to negotiate with borrowers or take other steps in the days ahead.

“I think this will happen with things like hotel or movie-theater loans that are going to have issues,” he says. “Lenders will require more margin, maybe more interest or better lender terms, and probably some dividend cuts for the mortgage REITs, even temporarily.”

Updated: 3-25-2020

Why The Commercial Mortgage Bond Market Looks Dire Right Now

Volatility is extreme, sellers are trying to sell.

Commercial real estate was supposed to be one of the safer bets of the past decade.

But the coronavirus has turned the whole notion of “safety” on its head, emptying streets, stores, hotels, office buildings and other shared spaces, as cities race to slow its spread. Uncertainty has left creditors bracing for an avalanche of missed payments.

How dire is it? Real estate appraisers aren’t likely to see buildings in person for weeks, or maybe even months from now, so unlike the deluge of expected worker layoffs, any actual markdown to real-estate values remains a long way off.

But carnage, like in the corporate debt markets, already can be found in commercial property bond prices where two weeks of dysfunction, margin calls and asset liquidations have taken a toll, particularly for investors buying bonds or making loans using borrowed money, called leverage.

“It’s a wonder to me that more people aren’t more careful with leverage, because that’s always been a killer in an environment like this,” Christopher Sullivan, a portfolio manager at the United Nations Federal Credit Union in New York, told MarketWatch on Wednesday.

“This is a true black swan event,” he said of the pandemic. “But market players also have made very little accommodation for the likelihood of it happening.”

And by one important measure — bond bid lists — there are still parties out there looking to raise cash, reduce their risk or simply dump swaths of exposure.

Wall Street dealers on Wednesday were circulating a nearly $2.1 billion list of mostly lower-rated commercial mortgage bonds under the title “liquidation” in the hopes of attracting bids.

The “talk,” or a rough guess of what dealers think the bonds might fetch, ranged from $20 prices to $90 prices, according to the list viewed by MarketWatch. Without defaults, bonds mostly repay at $100 prices.

U.S. stocks on Wednesday saw a bit more reprieve from expectations that Congress will soon pass into law a near $2 trillion aid package to offset the coronavirus outbreak fallout, with the Dow Jones Industrial Average DJIA, +2.39% finishing the day up 2.4%.

Tom Barrack, chief executive of Colony Capital Inc, warned in a weekend post of a “domino effect” of margin calls, foreclosures and borrower defaults in the nearly $16 trillion U.S. commercial real estate debt market from the “invisible enemy” of COVID-19, the disease caused by the coronavirus.

Importantly, unlike corporate bonds, most commercial property bonds are not yet eligible for sweeping rescue facilities rolled out this month by the Federal Reserve to help restore order to rattled financial markets.

The hope is for a broader backstop soon, particularly since commercial real estate bonds could be vulnerable to a wave of downgrades, as they were a decade ago, if credit conditions stay stressed and property owners start defaulting.

Like a decade ago, shares of publicly traded mortgage companies that rely on leverage to boost their lending and bond-buying capacities have been punished, sometimes by taking $1 worth of assets and turning it into as much as $15 by borrowing $14.

But recent record bond outflows have stung money managers too.

Deutsche Bank analysts led by Ed Reardon found that money managers far outpaced others in terms of offering “for sale” bonds on Wall Street’s bid lists over the past two weeks.

Here’s their chart showing the nearly $10 billion surge in commercial mortgage bonds offered on bond bid lists during the first three weeks of March.

“Last week, most of the lists weren’t even getting bids,” said Adam Murphy, founder of Empirasign, a platform that tracks bond-trading activity. He also said that some sellers this week instead are turning to “all-or-nothing” lists.

“The reason for that can be twofold,” he said. “Either you get a margin call and need to liquidate multiple positions simultaneously. Or it’s people trying to find a more expedient method of transacting.”

Updated: 7-22-2021

Zero-Down Mortgages Stoke U.S. Subprime-Like Fears In Canada

They’re the kind of exotic mortgages that one typically associates with the reckless, go-go housing market that gripped the U.S., circa 2005: Put down 5% cash and get 3% back; or, wilder yet, put down nothing at all. So when these products — and others like them — started popping up in the normally cautious Canadian financial industry, it raised alarm among policy makers in Ottawa.

This is year twenty-five of the great Canadian housing bull market, a nearly uninterrupted straight line up that has few parallels in the world. At a time of soaring real-estate prices all over the globe, only one major economy — New Zealand — has a frothier housing market than Canada, according to an analysis by Bloomberg Economics.

And after all those years of price gains, including a 21% surge since the pandemic began, millions of middle-class Canadians have no chance of scrounging together the money needed to make a conventional down payment of 20%.

In Whitby, a booming Toronto suburb nestled against the banks of Lake Ontario, this is a lament that mortgage broker Sherry Corbitt hears constantly from first-time home buyers. More than half of them, she says, are opting for loans that either allow them to borrow the money for their down payment or that provide cash back after the closing. A year ago, these products made up a small fraction of her business.

Asked whether this worries her at all, Corbitt, who works with some of Canada’s biggest banks, whips out a statistic she’s proud of: In her 13 years in the industry, not a single client has defaulted. “We’re never going to see what happened in the States,” she declares. “It’s just not possible here.”

Perhaps. The Canadian housing market has defied gravity for so long that the vast bulk of outspoken bears and Cassandras have fallen silent after years of erroneously calling for an imminent collapse.

In some circles, in fact, the opposite concern has begun to emerge — that prices will inexorably grind higher, year after year, deepening inequality and sucking up ever-greater quantities of capital and labor that could be used more productively in other sectors of the economy.

And yet, the boom in riskier loans has begun to chip away at the most crucial of the three pillars that industry insiders cite over and over as the solid foundation on which the housing rally is built: conventional, conservative lending practices. (Rising demand and tight supply are the other two.)

Canada may still have a raft of regulations that prevents the riskiest of applicants — those who fell into the subprime category in the U.S. in the aughts — from ever getting a mortgage, but many of those who are approved for loans today are taking on debt loads that were once unthinkable.

Tiff Macklem, the governor of the Bank of Canada, and his staff have started to publicly express concern. In the bank’s annual Financial System Review, released in May, policy makers signaled the risks posed by a deterioration in the quality of home loans.

Bank Of Canada Warns Home Buyers Rates Will Eventually Rise

They pointed to borrowers financing bigger chunks of their purchases as a primary concern. This is “the most economically significant factor associated with future financial stress,” the report said.

Often these massive loans are being taken out by borrowers with relatively low incomes. Mortgages considered to have a high loan-to-income ratio — when the principal is at least 4.5 times the borrower’s annual income — accounted for about 17% of new insured home loans in the fourth quarter. Two years earlier, they made up just 6.5%.

A separate Bank of Canada survey of loan officers showed they have loosened mortgage lending conditions in each of the past three quarters.

For Macklem, the angst is compounded by the prospect of rising inflation and higher benchmark interest rates, which would quickly drive up borrowing costs for millions of homeowners in a country where, unlike in the U.S., most borrowers have mortgages on which the rate is reset every five years or less.

Under Macklem’s guidance, the central bank has been among the first central banks in the developed world to pare back the monetary stimulus injected into the economy at the outset of the pandemic. Traders now expect the bank to begin lifting its benchmark rate from 0.25% over the next 12 months, and to raise it three more times in the two years after that.

David Rosenberg, one of the few Canadian real-estate bears still expressing his views publicly, says Macklem has latched onto a key concern. Rosenberg thinks the first of the rate hikes may come even sooner than markets are predicting, given how high inflation is, and that this could wind up pushing down housing prices and triggering a cascade of defaults. (So far, mortgage delinquencies remain at rock-bottom levels — about 0.25%.)

“When you look at loan-to-value ratios, it doesn’t take much to tip the balance to negative homeowner equity,” said Rosenberg, who runs Rosenberg Research & Associates Inc. in Toronto.

Rosenberg made his name in finance when, as chief North America economist for Merrill Lynch, he called the U.S. housing market a bubble two years before it burst. He liberally uses that term again now in reference to the Canadian market. “It is a massive bubble and an accident waiting to happen,” he said in an interview.

Popular with the global jet-setting crowd, the west coast city of Vancouver is the most expensive housing market in all of Canada. It is, as a result, also home to a great many of the country’s heavily indebted middle-class homeowners.

Josh Doornenbal is one of them.

A couple months ago, he plunked down C$1.1 million (about $870,000) for a three-bedroom house in the suburb of Langley for his family of five. He borrowed over C$800,000, an amount that equals more than eight times the C$100,000 annual salary he makes at an IT firm.

It’s a staggering amount of debt — nearly double the Bank of Canada’s threshold for identifying highly leveraged borrowers.

Even for loan officers increasingly ready to take on risk, it was an unnerving sum. Doornenbal, 33, pledged the home’s basement rental suite as a source of income — he figures it’ll pull in about C$2,300 a month — to bring down the debt ratio.

After many rejections, he found a credit union willing to green-light his loan application. Credit unions, which are provincially-regulated in Canada, are among those willing to underwrite some high-ratio mortgages, along with nonbank specialty lenders and major banks.

“We worked hard to find a real creative solution,” Doornenbal said.

Terri Szego, a portfolio manager and investment adviser at Bank of Montreal, has another gauge to measure how stretched home buyers are: the number of her clients who call for advice on how to help their children make down payments. When she took the job 17 years ago, those conversations were exceedingly rare. They picked up about five years ago, she says, and then, around 2019, they suddenly became much more frequent.

Cash gifts typically range from C$10,000 to C$100,000 or more, Szego says. To her, that aid is often a sign that her clients’ kids are getting in over their heads. Like Macklem and Rosenberg, she frets about a rise in interest rates.

“What happens when these big prices have been paid, these big loans have been taken out and mortgage rates start to go up?” Szego says.

There are, of course, plenty of housing bulls who are unimpressed by these concerns.

Exotic products like zero-down mortgages, they note, remain a small percentage of all mortgages, and any home loan with less than 20% down must be insured against default. That’s part of the reason why losses from bad mortgages have been minuscule at major Canadian banks in recent years.

What’s more, they argue the hand-wringing about the Josh Doornenbals of the world is misguided. Loan size isn’t as crucial a metric in determining future default rates as is the strength of the borrower’s future income, and by all accounts, Canadians’ paychecks are healthy and stable.

“Shocks to income, shocks to cash flow, are the real threat to real estate markets, more than any marginal movements in interest rates,” says Murtaza Haider, a professor who teaches real estate management at Toronto’s Ryerson University.

Back in the Toronto suburbs, Corbitt, the mortgage broker, is busier than ever.

Her business jumped 60% last year and is on pace to surge another 20% this year, she said. Much of this growth is coming from people who are getting pushed out of their rental homes by landlords who’ve decided to sell their properties amid the boom.

Rather than hunt for a new rental in a suddenly fiercely competitive market — bids pour in for properties as soon as they’re listed — folks are opting to take the plunge and buy. This is what drove Doornenbal’s decision, too.

“Well if I have to be evicted,” Corbitt says clients tell her, “maybe now’s the time to buy.” It all feels a little rushed, she acknowledges. “A lot of first-time buyers are not ready.”


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