Scotiabank not worried about its floating-rate portfolio
With variable rates rising by the month—and more Bank of Canada hikes anticipated—observers are keeping a careful watch on adjustable-rate mortgages.
Borrowers with an Adjustable-Rate Mortgage (ARM) see their monthly payments increase every time interest rates rise (to the tune of about $25 per $100,000 for every 50 bps of rate increase, based on a 25-year amortization).
The Bank of Canada has already delivered 125 basis points of tightening this year, with another 100 to 150 bps expected.
But Scotiabank, the largest mortgage lender that offers ARMs, said during its last earnings call that it’s not concerned about its adjustable-rate portfolio in spite of the current rising-rate environment.
“We’re not worried about the credit portfolio for the [variable-rate mortgage] book,” said Dan Rees, Group Head, Canadian Banking. “The conversion rate out of variable into fixed has been accelerating over the last number of months as prices have been rising. That’s a trend we’ve anticipated.”
Rees went on to address the adjustable feature of Scotia’s variable-rate mortgage products.
“We do think—and we believe very strongly—that a variable mortgage should have a payment that varies. We think that’s good for customers,” he said, adding that the bank has already proactively reached out to “tens of thousands” of customers who “might be vulnerable to an adjustment in their monthly payment amount.”
Rees added that the average variable-rate mortgage balance at the bank is roughly $400,000, and that for every 100 basis points of rate increases, monthly expenses would increase about $250 “on an expense base of a household of over $5,000.”
“This is not a significant adjustment,” he said.
Rees added that income levels tend to be higher for those that take floating-rate products and that many “have been doing so for a long time because payment levels are lower.”
The following are highlights from Scotiabank’s, BMO’s and TD Bank’s second-quarter earnings, with pertinent sections highlighted blue.
Q2 net income: $2.75 billion (+12% Y/Y) Earnings per share: $2.18
The total portfolio of residential retail mortgages rose to $272 billion in Q2, up from $235 billion a year ago.
28% of the bank’s residential mortgage portfolio is insured. Of the uninsured balances, the average loan-to-value of this portfolio is down to 47% from 55% in 2019.
Residential mortgage volume was up 16% year-over-year.
Net interest margin rose to 2.22% from 2.19% in Q2 2022 due to “higher deposit spreads and the impact of the Bank of Canada rate increases.”
Mortgage loans that were 90+ days past due fell to 0.10% from 0.12% in Q1 and 0.17% a year ago.
Scotia’s provisions for credit losses fell another $187 million in Q2, “due to improving credit performance net of growth of our Canadian retail portfolio…” said Phil Thomas, Chief Risk Officer. That’s down from a peak of $2.2 billion in Q3 2020.
“An immediate and sustained +100 bps parallel shift [in policy rate] would have a negative impact on annual net interest income of $126 million for Year 1 and a positive impact of $191 million for Year 2,” Scotia noted. It currently expects 150 bps more in Bank of Canada tightening by the end of the year.
The bank’s gross impaired loans ratio improved by four basis points to 64 basis points since peaking in Q1 of 2021 at 84 basis points. “We continue to see a positive trend with lower formations,” said Thomas.
On the bank’s falling provision for credit losses (PCL), Chief Risk Officer Phil Thomas said this: “We’ve reached the floor this quarter for PCLs and expect provisions to gradually increase in the latter half of the year.”
Asked about whether there are any concerns given the current economic forecast, Thomas said this: “…we’re seeing people paying down loans over the last two-year period of 3%. We’ve seen investable assets increase in our…Canadian consumer portfolio about 13%…We’ve had improvements in our FICO scores of our customers over the last couple of years on average within our credit book from 720 to 750 in our mortgage book from 750 to 790. So, all this gives us really good confidence in terms of what we’re seeing with our customers.”
Porter added, “we run rigorous stress tests here in the bank of all our portfolios in Canada; international, corporate and commercial…that would have more harsh inputs today than we would have possibly a year ago.”
Asked about Scotiabank’s unique variable mortgage product where payments rise and fall as rates fluctuate, Dan Rees, Group Head, Canadian Banking, replied,“We’re not worried about the credit portfolio the VRM book. Two-thirds of the book is fixed,” he said. “The conversion rate out of variable into fix has been accelerating over the last number of months as prices have been rising. That’s a trend we’ve anticipated.”
The bank’s net interest margin (NIM) in Canadian Personal and Commercial Banking was down 2 bps from last quarter due to higher deposit margins, but Chief Financial Officer Tayfun Tuzun said NIM is expected to increase in the second half of the year given the rising rate environment.
“…we remain well-positioned for the rising rate environment,” he said. “A 100-basis-point rate shock is expected to benefit net interest income by $635 million over the next 12 months.“
In Canadian Personal and Business Banking, impaired loan losses were $79 million, unchanged compared to Q1.
“We do expect our impaired [Provision for Credit Losses] rate to drift slowly back up [from 10 bps this quarter] to a level more consistent with our pre-pandemic experience, which was consistently high teens to low 20s in terms of basis points,” said Chief Risk Officer Pat Cronin. “While it’s difficult to predict the timing of when that level will be reached, given that the current portfolio credit metrics remain quite strong, I would expect that normalization to start towards the end of this year or into fiscal 2023.”
“We’ve reached the floor this quarter for PCLs and expect provisions to gradually increase in the latter half of the year,” said Phil Thomas, Chief Risk Officer. “All-bank PCLs are $219 million, or 13 basis points, driven by a net reversal from performing loan PCLs in Canadian Banking and Global Banking and Markets. Strong loan growth and a less favourable macroeconomic forecast were offset by continued improvement in credit performance.”
“We’ve had improvements in our FICO scores of our customers over the last couple of years on average within our credit book from 720 to 750 in our mortgage book from 750 to 790,” said Thomas.
Asked about changing market conditions and whether the bank’s underwriting appetite had changed, said Ajai Bambawale, “We’re not going to change our credit parameters.”
“You’ve heard from us many times where through the cycle underwriters and we’d like to keep our underwriting standards consistent, and that’s the intent. So we would not change our underwriting standards, unless we thought there was going to be unexpected loss, Bambawale added. “We’re actually seeing very good quality on our res book, whether it’s HELOC or residential mortgages.”