Model how much the stock prices Canadian banks would be affected by large defaults given that a large number of low interest rate fixed mortgage that will be renewed this year. Also look at other factors affecting bank stocks over the next 18 to 24 months. Provide a chain of thought.
Model how much the stock prices Canadian banks would be affected by large defaults given that a large number of low interest rate fixed mortgage that will be renewed this year. Also look at other factors affecting bank stocks over the next 18 to 24 months. Provide a chain of thought.
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The Motley Fool Canada
What to Know About Canadian Bank Stocks for 2025 - The Motley Fool
Bank of Canada
How well can large banks in Canada withstand a severe ...
Yahoo Finance
What to Know About Canadian Bank Stocks for 2025 - Yahoo Finance
cmhc-schl.gc.ca
Residential Mortgage Industry Report Spring 2025 Edition
Chain of Thought: Modeling the Impact of Mortgage Renewals and Defaults on Canadian Bank Stocks1. Context: Mortgage Renewals and Default Risk
- In 2025 and 2026, about 60% of all outstanding Canadian mortgages will come up for renewal. Most are five-year fixed-rate mortgages originated during the pandemic at record-low rates 5.
- While rates are expected to rise for about 60% of these renewals, the increases will be smaller than previously feared due to recent declines in interest rates 5 4.
- Most borrowers were stress-tested at higher rates, and over 90% of those with five-year fixed mortgages are expected to face payment increases within their stress-tested range 5.
- Many households have seen income growth and have significant home equity, providing a buffer against payment shocks 5.
2. Stress Testing and Default Scenarios
- The Bank of Canada and IMF have conducted stress tests simulating severe economic shocks (e.g., a 5% GDP contraction, unemployment above 9%, and a sharp correction in house prices) 5.
- In a severe recession scenario, Canadian banks could face credit losses totaling $123 billion over three years, representing a 4.4% loss rate on initial loan balances—higher than during previous downturns 2.
- These stress tests suggest that while losses would be significant, Canadian banks are well-capitalized and resilient, with strong capital positions (e.g., CET1 ratios above regulatory minimums) 5 9.
3. Modeling Stock Price Impact
- If defaults rise sharply due to mortgage payment shocks, two main mechanisms would pressure bank stock prices:
- Increased provisions for credit losses, reducing earnings 2 6.
- Negative investor sentiment and lower valuation multiples due to heightened risk 6.
- Historically, a severe recession with elevated defaults could lead to double-digit declines in bank stock prices, especially if earnings drop and outlooks worsen 6.
- However, current data suggest that while some households will struggle, widespread defaults are unlikely due to stress testing, income growth, and home equity buffers 5.
- Thus, a base-case scenario would likely see only moderate increases in defaults and manageable impacts on bank earnings, limiting stock price declines. In a worst-case (severe recession) scenario, losses and price declines would be more pronounced but still within the banks' ability to absorb without systemic risk 2 5 6.
4. Other Factors Affecting Bank Stocks (Next 18–24 Months)
- Interest Rate Environment: The Bank of Canada is expected to continue lowering rates, which reduces net interest income for banks but also eases pressure on borrowers 1 3 8.
- Earnings Growth: Bank earnings may have peaked, with growth slowing due to lower rates and margin compression 1 3.
- US Operations and Regulatory Risks: Some banks (e.g., TD) face challenges in their US businesses, including fines and regulatory scrutiny, which can dampen overall performance 1 7 9.
- Economic Growth and Trade: Broader economic conditions, including trade tensions and the risk of recession, will influence loan demand, credit quality, and investor sentiment 1 3 7.
- Capital Strength and Diversification: Canadian banks remain well-capitalized and diversified, with many showing resilience and even growth in recent earnings reports 9.
Summary Table: Key Factors and Their Effects
FactorExpected Effect on Bank Stocks (2025–2026)<tbody]| mortgage="" renewals="" (higher="" payments)<="" td=""] | modest="" default="" risk;="" most="" borrowers="" can="" absorb="" shocks<a="" href="https://www.bankofcanada.ca/2025/05/financial-stability-report-2025/"]5 | | severe="" recession="" scenario<="" td=""] | credit="" losses="" up="" to="" 4.4%="" of="" loans;="" stocks="" could="" drop="" double="" digits="" but="" banks="" remain="" solvent<a="" href="https://www.bankofcanada.ca/2022/05/staff-analytical-note-2022-6/"]2 5 6 | | lower="" interest="" rates<="" td=""] | squeeze="" net="" interest="" margins;="" moderate="" earnings="" pressure<a="" href="https://www.fool.ca/2025/03/07/what-to-know-about-canadian-bank-stocks-for-2025-3/"]1 3 8 | | regulatory="" and="" us="" business="" risks<="" td=""] | possible="" negative="" surprises="" for="" banks="" with="" large="" us="" exposure<a="" href="https://www.fool.ca/2025/03/07/what-to-know-about-canadian-bank-stocks-for-2025-3/"]1 7 9 | | economic="" growth="" trade="" tensions<="" td=""] | potentially="" weaker="" loan="" demand="" and="" higher="" credit="" risk<a="" href="https://www.fool.ca/2025/03/07/what-to-know-about-canadian-bank-stocks-for-2025-3/"]1 3 7 | | capital="" strength="" diversification<="" td=""] | provides="" resilience="" and="" limits="" downside="" risk<a="" href="https://www.bankofcanada.ca/2025/05/financial-stability-report-2025/"]5 9 |
ConclusionCanadian banks face a challenging period with a large volume of mortgage renewals and potential for increased defaults, but most borrowers are well-positioned to handle higher payments due to prior stress testing, income growth, and home equity 5. While a severe recession would cause significant credit losses and could lead to double-digit stock price declines, current stress tests and capital buffers indicate banks would remain resilient 2 5 6. Over the next 18–24 months, lower interest rates, slowing earnings growth, regulatory risks, and macroeconomic conditions will also shape the outlook for Canadian bank stocks 1 3 7 8 9. Overall, the sector is likely to experience volatility but is not at high risk of a systemic crisis under current conditions.
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How would large defaults on fixed mortgages impact Canadian bank stock prices over 18-24 months
How would large defaults on fixed mortgages impact Canadian bank stock prices over 18-24 months
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QV Investors
How A Recession Could Impact Stock Prices of Canadian Banks
reddit.com
Canadian Bank Stocks? Why aren't they falling significantly if ...
Bank of Canada
Financial Stability Report—2025 - Bank of Canada
Bank of Canada
Indicators of financial vulnerabilities - Bank of Canada
Impact of Large Defaults on Fixed Mortgages: Canadian Bank Stock Prices (18–24 Months Outlook)Rising Defaults: The Mortgage Cliff and Bank Exposure
- Over one million fixed-rate mortgages in Canada are set for renewal in 2025, many originally contracted at ultra-low rates. Renewals at much higher rates are expected to trigger significant payment shocks, increasing the risk of defaults, particularly among households with high debt loads or limited equity 5 6.
- Mortgage delinquencies have already risen from 0.14% in 2022 to 0.20% in late 2024, with projections suggesting further increases as the "mortgage cliff" unfolds 5 6.
- If 5% of the $300 billion in renewing mortgages default, this could result in $15 billion in bad debt, a level of stress that would force banks to further increase their provisions for credit losses 5.
Stock Price Mechanism: How Defaults Feed Into Bank Valuations
- Large defaults directly impact bank earnings through increased credit losses and higher loan loss provisions. This reduces profitability and can trigger negative earnings surprises 1 5.
- Investor sentiment is also affected: a rising risk of household defaults and deteriorating economic conditions typically lead to lower valuation multiples for bank stocks, as investors price in higher uncertainty and weaker future earnings 1.
- Canadian banks have increased their reserves for expected credit losses to levels approaching those seen during the global financial crisis, reflecting growing concern about the mortgage sector’s stability 5.
Magnitude of the Impact: Historical and Projected Effects
- Historically, recessionary periods or spikes in credit losses have led to double-digit declines in Canadian bank stock prices. The combination of rising defaults, declining home prices (down 15–20% in some regions), and a slowing economy could push bank stocks lower, especially if the market perceives that provisions are insufficient or that losses will persist 1 5.
- The actual impact will depend on the scale of defaults. A moderate rise in delinquencies would likely result in a single-digit percentage decline in bank stocks, while a severe wave of defaults (as modeled above) could trigger a 10–20% drop over the next 18–24 months, especially if accompanied by a broader economic downturn 1 5.
Mitigating Factors
- A significant portion of Canadian mortgages are insured (e.g., by CMHC), which limits direct losses for banks, though uninsured segments and private lenders are more exposed 2 5.
- Canadian banks remain well-capitalized and have proactively increased provisions, which helps buffer the immediate impact, but sustained or escalating defaults could still pressure share prices and earnings 3 5.
Summary Table: Chain of Impact
Event/FactorImmediate Effect on BanksStock Price Impact (18–24 Months)<tbody]| large="" mortgage="" defaults<="" td=""] | higher="" credit="" losses,="" lower="" profits<="" td=""] | likely="" 10–20%="" decline="" if="" severe<="" td=""] | | increased="" loan="" loss="" provisions<="" td=""] | lower="" reported="" earnings<="" td=""] | negative="" sentiment,="" lower="" valuations<="" td=""] | | falling="" home="" prices<="" td=""] | higher="" risk="" of="" negative="" equity<="" td=""] | amplifies="" default="" risk="" and="" stock="" declines<="" td=""] | | economic="" downturn<="" td=""] | weaker="" loan="" growth,="" more="" defaults<="" td=""] | further="" pressure="" on="" bank="" stocks<="" td=""] | | mortgage="" insurance="" coverage<="" td=""] | limits="" some="" direct="" losses<="" td=""] | moderates,="" but="" does="" not="" eliminate,="" risk<="" td=""] |
ConclusionIf large defaults materialize as fixed-rate mortgages renew at higher rates, Canadian banks will likely face a notable increase in credit losses and provisions, leading to reduced earnings and negative investor sentiment. This scenario could drive bank stock prices down by 10–20% over the next 18–24 months, particularly if defaults are widespread and coincide with a broader economic slowdown. However, the impact may be partially cushioned by mortgage insurance and strong bank capital positions, though risks remain elevated as the mortgage cliff approaches 1 3 5 6.
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