October 27, 2013
Regarding commercial loans: It's really hard to get a small business loan and they often want you to put up your house for it. It's a high risk loan, and they know it. They also charge way above mortgage rates for it, so there is lots of profit there to offset losses, assuming most debt is paid.
They are more willing to loan to big corporations. These often have some real assets and there is the hope/expectation that if they got into big trouble, the government would offer them a helping hand. They DO regularly get into trouble, and often it is the taxpayer who is left holding the bag (with a hole in it) , and then they flee to another country.
I am thinking more of the alternative lenders, e.g. the credit unions and small banks not publicly traded making loans to local businesses. The big boys can take care of themselves in one form or the other, including raising capital via share issues.
October 21, 2013
CUs also issue shares which members can buy, and they seem to be very popular. The rates are similar to bank dividends and are vulnerable as are bank dividends. CU investment shares are much harder to unload than bank common shares, so should provide good stability, depending on how much is outstanding.
A couple of small CUs that I belong to, with deposits around 160 million, reported 1 default each last year, and these were both mortgages with a recoverable asset. It would be interesting to know how this compares to banks' loan books. I think they have a ways to go before there is a crisis. One of the two (I don't know about the other) has set the bar for what they will fund higher than that mandated by law for the banks and they turn people away regularly because of this and/or convince them to buy less expensive properties. Their smaller size may make them more vulnerable but it may also make them more cautious.
I mention only these two because they are the only ones I have this information on.
We have seen over and over again how some of the biggest banks in the world get caught with loan defaults on higher risk lending. They do it because they are big and they figure they can afford the risk because they can foresee good profits. Sometimes they win and sometimes they lose.
Some of the smaller banks like HCG and EQ seem to specialize in riskier mortgages but not so much small business loans as far as I know (and I may not be fully informed). Higher losses are therefore expected, but are also intended to be offset by higher rates and lower dividends to investors, at least in some cases. With higher rates, you also get higher spreads and higher margins. I can't speak to how effective this might be in future, but the theory seems sound. Buffett was certainly impressed with HCG's loan book a few years ago, and ran laughing all the way to the bank, begging for more. (Me? As a "little guy", I just bought more GICs from HCG when they were desperate enough to pay 3.5 when others were well below 3; have been very happy with this.)
April 6, 2013
Bad choice of words on my part. I recognize the initial deposit was used to make the loan, but that liability is still on the books and the FI has to come up with the cash IF the depositor wants to transfer out their account balances. It is still a potential cash flow issue (subject to reserves on hand of course). A run on the bank aka HCG 3 years ago is an example in the extreme.
Liquidity is managed regardless of whether the loan has defaulted or not.
Many mortgages that are not in default, for example, are routinely not paid off at the end of the term. People often renew their mortgage for another few years. However, the GIC deposits that were funding the mortgage may not be rolled over. Sometimes, the GIC's mature weeks before!
Those liquidity considerations are routinely handled by a bank.
From a liquidity perspective, there isn't a big difference between a loan that is renewed and not paid off and a loan that has defaulted.
April 6, 2013
Some of the smaller banks like HCG and EQ seem to specialize in riskier mortgages but not so much small business loans as far as I know (and I may not be fully informed). Higher losses are therefore expected, but are also intended to be offset by higher rates and lower dividends to investors, at least in some cases. …
Higher losses are not always the case. I think it was Equitable Bank that was considering reducing the amount they were provisioning for losses. They were following industry standards for the amount they were provisioning. But, they found that the actual losses were significantly less than what they had been provisioning.
Also, defaults don't necessarily mean actual losses. Should there be a default on a mortgage with the borrower making an 80% down payment, there would be a very good chance the lender will recover the money lent, the interest, and the foreclosure cost. Is such a mortgage really risky when the borrower doesn't have a credit record yet with Equifax and TransUnion?
October 21, 2013
April 6, 2013
I think Equitable Bank will do a second mortgage if the situation makes sense. The alternative lenders will examine each situation and decide. That's how such lenders have built their business.
The big banks used to decline mortgage applications from applicants who can put 80% down but do not have an Equifax or TransUnion credit history. Such applicants had to go to lenders like Equitable Bank. Equitable Bank knew the situation, approve the mortgage, and charge the applicant a higher rate. Higher rate for not much extra risk!
That's why most of the mortgages are not renewed at alternative lenders. After a year or two, the applicant has a credit history and can go to one of the big banks for a prime mortgage at a lower rate.
It is not as easy now as the big banks realized what they were leaving on the table. Some of them have special lending units, like a new immigrant unit, that can approve mortgages to people who can put 80% down but don't have a Canadian credit history.