|Canadian Regulators Taking Closer Look At HELOCs|
May 04, 2012 Caroline Van Hasselt online.wsj.com
TORONTO (Dow Jones)--Amid the double-barrel threat of soaring household debt and rising home prices across Canada, regulators are taking aim at one of the most popular--and controversial--lending practices by the country's big banks.
Home equity lines of credit, or HELOCs, have soared in recent years, even after similar lending helped fuel the ill-fated U.S. housing market bubble. Canada's largest banks--which have generally won praise for conservative lending that protected them from the worst of the financial crisis--defend the loans.
Canadian household debt stands at near-record highs, just over 150% compared to disposable income. Canadian officials, including central bank chief Mark Carney, have warned repeatedly that household debt is the single biggest threat to the otherwise resilient Canadian economy.
Much of that debt has been tied to mortgages taken out to buy property amid Canada's super-charged housing market. But another big chunk is down to HELOC lending.
HELOCs--loans secured by the equity in a borrower's home--surged 170% over the past decade since 2001, or twice the rate of mortgage growth, according to the Bank of Canada. Last year, they accounted for 50% of total consumer credit, up from 11% in 1995, around the time when HELOCs first started to appear here.
HELOCs accounted for C$183 billion, or 13%, of Canada's big six banks' domestic loans, according to Barclays research, based on data from Canada's Office of the Superintendent of Financial Institutions, the country's top banking regulator.
The loans are popular for several reasons. For borrowers, they're typically cheaper than second mortgages. For lenders, they help hold onto customers, who might otherwise shop around for other loan options.
Banks defend them as useful tools for borrowers to prudently get through tough times or finance unexpected expenses. "It's a great product to manage through an economic cycle," said David McKay, Royal Bank of Canada's (RY) group head for Canadian banking.
But regulators are taking a harder look. Julie Dickson, OFSI's chief, recently criticized some lenders' practice of issuing HELOCs with a loan-to-value ratio of as much as 80%--meaning they allow some homeowners to take out 80% of the value of their property.
Last month, OSFI issued draft guidelines for banks that propose dropping maximum HELOC loan-to-value ratios to 65%, from 80%, and amortizing outstanding HELOCs over fixed terms.
Canadian banks say they have largely stayed away from such high-ratio HELOCs and require significant equity in a home in the first place.
"You're starting with a minimum of 20% equity in the home, which is quite significant," said RBC's McKay. That "gives you a very large cushion against any systematic change in the value of housing," he said.
Bank of Montreal, (BMO) the only one of Canada's big six banks to disclose its HELOC ratios, said it averages a 54% loan-to-value rate.
Last April, concerned about the high issuance of HELOCs, the Canadian government stopped insuring them. Banks are generally protected from a major housing-market correction because most of their higher-risk mortgages are backed by the government.
Banks, citing their own stress tests, have said they'd see minimal losses even if housing prices fell by 30%. Still, "no model can truly predict reality," said Barclays analyst John Aiken. "The problem is we don't know, when push comes to shove, whose credit adjudication process is better than others because they haven't been stressed."
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