WEBVTT - China’s Debt Powder Keg; Canada Faces Mortgage Test 0:00:14.520 --> 0:00:17.440 Hello, and welcome to the Credit Edge for Weekly Markets podcast. 0:00:17.840 --> 0:00:20.800 My name is James Crombie. I'm a senior editor at Bloomberg. 0:00:21.480 --> 0:00:23.360 This week, we're very pleased to have on the show 0:00:23.600 --> 0:00:27.000 Way Sho, who covers credit markets for Bloomberg News in 0:00:27.080 --> 0:00:27.600 Hong Kong. 0:00:27.960 --> 0:00:30.760 How are you Way, I'm good, it's a nice day 0:00:30.800 --> 0:00:31.440 in Hong Kong. 0:00:31.920 --> 0:00:34.400 Great, Okay. We're also delighted to welcome back to the 0:00:34.400 --> 0:00:37.239 show him Manshu Bakshi, who focuses on banks at Bloomberg 0:00:37.280 --> 0:00:39.800 Intelligence in New York. We'll be coming back to him 0:00:39.800 --> 0:00:42.640 Anshew in a bit later to talk about trouble bringing 0:00:42.640 --> 0:00:46.199 in Canada. So do stay with us. But first way, 0:00:46.320 --> 0:00:50.240 Joe with Bloomberg News, let's talk about China. You're writing 0:00:50.240 --> 0:00:52.640 a lot about local government finances at the moment, and 0:00:52.640 --> 0:00:55.520 there's a bit of a crisis going on. What are 0:00:55.840 --> 0:00:59.240 local government financing vehicles and how do they work here? 0:01:00.200 --> 0:01:04.720 They are special vehicles set by the local governments of 0:01:04.840 --> 0:01:11.600 China to usually help with infrastructure projects like subways or 0:01:11.760 --> 0:01:15.320 high roads. They are kind of like what's first set 0:01:15.400 --> 0:01:21.600 up to skirt around the bank. Municipal authorities borrow directly 0:01:21.680 --> 0:01:25.240 from banks or selling bounds directly in the market. 0:01:26.160 --> 0:01:29.920 So instead of going to the market the municipality or 0:01:29.920 --> 0:01:31.679 the state. Is it a city as. 0:01:31.560 --> 0:01:36.440 Well, Yeah, it's on both a city level, county level, 0:01:36.560 --> 0:01:37.720 or provincial level. 0:01:38.319 --> 0:01:42.800 Okay, so they go they set up a special special 0:01:42.880 --> 0:01:47.520 purpose vehicle in order to get funding for an infrastructure project. 0:01:47.920 --> 0:01:53.280 Yeah, it's usually the case because generally LGF within China, 0:01:53.360 --> 0:01:58.680 they are kid grass as a corporate dat so investors 0:01:58.720 --> 0:02:03.160 generally assume that local governments are held responsible for them. 0:02:03.440 --> 0:02:07.040 Okay, so how much debt do they have and what 0:02:08.240 --> 0:02:10.280 form is it in? I guess it's in local bonds. 0:02:10.720 --> 0:02:16.600 Yeah, they constitute a large part bunk of the local 0:02:16.720 --> 0:02:22.440 debt market. It is estimate they have about a thirteen 0:02:22.480 --> 0:02:26.440 point five trillion un of outstanding on shore bounds at 0:02:26.639 --> 0:02:30.840 end of twenty twenty two, to give you an idea, 0:02:31.040 --> 0:02:35.760 that's probably about forty percent of China's non financial corporate 0:02:35.880 --> 0:02:41.960 debt market. So that's a significant part of the market. 0:02:42.200 --> 0:02:43.600 Do we know that is in dollars? 0:02:43.960 --> 0:02:46.639 Yeah, that's about like two trillion dollars. 0:02:46.720 --> 0:02:50.040 Actually, well, it's a big chunk of debt. So you 0:02:50.080 --> 0:02:52.440 say that they set up these vehicles. You know, if 0:02:52.480 --> 0:02:55.399 we look at the US muni market, for example, we'd 0:02:55.440 --> 0:02:58.320 expect the state or the local government's borrowing to be 0:02:58.400 --> 0:03:01.239 directly responsible for paying that much back. Do the vehicles 0:03:01.760 --> 0:03:05.720 help these borrowers somewhat like skirt the obligation. 0:03:06.400 --> 0:03:10.680 Yeah, because, as I said, theoretically they are actually coperated 0:03:10.760 --> 0:03:16.800 that so the local government are not naturally assumed to 0:03:16.919 --> 0:03:22.520 hold responsible for them. But in reality, everybody know it's 0:03:22.560 --> 0:03:25.720 the dat issued by the government. So I guess the 0:03:25.760 --> 0:03:28.720 local government kind of have the model has the issue 0:03:28.760 --> 0:03:34.160 here because investors do expect them to come to rescue 0:03:34.240 --> 0:03:36.360 if there is a problem, right. 0:03:36.280 --> 0:03:38.480 So right now we do have a problem. Can you 0:03:38.520 --> 0:03:41.960 talk us through the actual crisis that's going on right now? 0:03:42.240 --> 0:03:47.000 Yeah, I guess the problem. You know, it's always there, 0:03:47.120 --> 0:03:51.880 but it's only made apparent better pandemic because during the 0:03:52.000 --> 0:03:56.520 three year of pandemics, the local garment's physical revenue they 0:03:57.000 --> 0:04:01.640 have they were like dropping in the meantime because of 0:04:01.800 --> 0:04:07.240 a crisis related to the China's privaty market. Uh, the 0:04:07.280 --> 0:04:11.200 big chunk of local garments revenue, which is land sale, 0:04:11.840 --> 0:04:16.640 also come to a slide. So I guess like the 0:04:16.680 --> 0:04:20.680 local governments are really struggling with their physical revenue, so 0:04:20.720 --> 0:04:26.960 they have fewer abilities to give subsidies to this local 0:04:27.000 --> 0:04:32.600 garnment financing vehicles. In the meantime, the local government financing 0:04:32.680 --> 0:04:38.120 vehicles are not really self sustainable, so we can see 0:04:38.320 --> 0:04:42.279 a few cases of last minute payment or cases of 0:04:42.480 --> 0:04:45.839 technical default of df with this year. 0:04:46.440 --> 0:04:49.080 So all of this money, there's there's two trillion dollars 0:04:49.120 --> 0:04:52.480 worth of money, and we're starting to see defaults on 0:04:52.880 --> 0:04:53.200 some of that. 0:04:53.800 --> 0:04:59.120 It's not really like default but more like technical defaults 0:04:59.160 --> 0:05:03.440 that only hours laid, hours past the deadline, but it 0:05:03.560 --> 0:05:07.440 still show the you know, the amount of pressure that 0:05:07.520 --> 0:05:08.239 they are facing. 0:05:08.800 --> 0:05:11.839 So the revenue that's coming in may not be enough 0:05:11.880 --> 0:05:14.680 to cover the money that they owe or the debt payments. 0:05:15.040 --> 0:05:21.039 Yeah, in fact, they would not be sustainable if they 0:05:21.080 --> 0:05:25.200 don't have the subsidies. Last year they receive the highest 0:05:25.279 --> 0:05:30.120 amount of subsidies on records, So without subsidies, a lot 0:05:30.160 --> 0:05:34.960 of them are actually operating at lost. That's not really 0:05:35.000 --> 0:05:37.279 a sustainable pattern for the future. 0:05:37.720 --> 0:05:39.479 Do we expect the subsidies to go away? 0:05:40.200 --> 0:05:44.920 The subsidies probably won't go away like right away, but 0:05:45.480 --> 0:05:49.000 we do not. Like China's economy is having a difficult 0:05:49.240 --> 0:05:54.320 year this year, and the unemployment rate is skyrocketing high. 0:05:55.080 --> 0:06:00.840 So the local government they are having difficulties, you know, 0:06:01.040 --> 0:06:05.520 like collecting physical revenues themselves as well. So it's not 0:06:05.839 --> 0:06:11.760 a certain how long they can continue that amount of 0:06:12.080 --> 0:06:13.640 subsidies in the long run. 0:06:14.080 --> 0:06:18.200 So we are starting to see what you could describe 0:06:18.279 --> 0:06:19.679 the default wave happening. 0:06:20.520 --> 0:06:25.560 We probably won't say a huge default wave happening soon, 0:06:26.160 --> 0:06:30.760 but we do say cases of financial stress, such as 0:06:30.960 --> 0:06:34.760 you know, like the agreements with the local banks to 0:06:34.920 --> 0:06:41.480 extend long terms, or like miss deadline for a few hours. 0:06:42.440 --> 0:06:47.400 So these cases of last minute payment do show that 0:06:47.640 --> 0:06:51.360 there is significant amount of stress in the market because 0:06:51.839 --> 0:06:56.039 it shows they basically exhaust all means to try to 0:06:56.680 --> 0:07:00.400 you know, make the payments. But I'm not sure how 0:07:00.480 --> 0:07:03.440 long they can you know, continue to do it in 0:07:03.480 --> 0:07:04.080 the long run. 0:07:04.920 --> 0:07:07.040 So, as you said, the subsidies are going away for 0:07:07.880 --> 0:07:12.000 these local government financing vehicles. That the acronym that we 0:07:12.040 --> 0:07:15.000 hear a lot is l g f V. In this context, 0:07:15.960 --> 0:07:20.280 the danger is that some of them just can't pay, 0:07:21.080 --> 0:07:23.240 maybe a lot of them can't pay. How does that 0:07:23.280 --> 0:07:26.800 all end them mean? It sounds pretty worrying if if 0:07:26.880 --> 0:07:30.400 all of that debt you know, are trillion dollars, two 0:07:30.400 --> 0:07:33.080 trillion dollars. Sorry, if US dollars in debt, if all 0:07:33.160 --> 0:07:36.360 that defaults at once, do we do we really expect 0:07:36.560 --> 0:07:38.320 a major catastroph at this point. 0:07:39.440 --> 0:07:45.040 Actually, even like those local garments that are struggling the 0:07:45.200 --> 0:07:52.280 most appear to be prioritizing timely bound payments because it's 0:07:52.440 --> 0:07:56.400 really would be a catastrophic signal it would send if 0:07:56.520 --> 0:08:00.760 it were unable to pay their way. But yeah, as 0:08:00.760 --> 0:08:03.840 I said, like some lf they've been really struggling and 0:08:04.160 --> 0:08:09.520 they've been making last minute payments. Yeah, but in a 0:08:09.560 --> 0:08:12.640 short term at least, the local governments are really trying 0:08:12.760 --> 0:08:14.920 to make dos at the moment. 0:08:15.880 --> 0:08:21.720 Okay, So, given the size of this crisis, and you know, 0:08:21.760 --> 0:08:25.080 the possible magnitude of it, what impact does it have? 0:08:25.160 --> 0:08:27.280 More broadly, does it start to affect growth in the 0:08:27.360 --> 0:08:28.240 Chinese economy? 0:08:29.160 --> 0:08:34.040 I guess, like the the Chinese economy is already having 0:08:34.440 --> 0:08:38.960 like a bump pay year this year, and if there 0:08:39.200 --> 0:08:42.240 is really a case of default happening in the market, 0:08:43.240 --> 0:08:47.880 it would create panic in the market, just like how 0:08:48.320 --> 0:08:52.920 it happened with the property crisis. You know, nobody expects 0:08:53.080 --> 0:08:56.960 every grand to default but once it's default, it's kind 0:08:57.000 --> 0:09:03.200 of uh, you know, the whole A series of other 0:09:03.360 --> 0:09:08.560 defauts follow suit. So I guess like no local government 0:09:08.720 --> 0:09:11.959 really want to be the first case. So they are 0:09:12.040 --> 0:09:16.120 trying to, you know, get all the support they need, 0:09:16.160 --> 0:09:21.720 including help from the central government to help make these 0:09:22.080 --> 0:09:23.280 timely payments. 0:09:23.559 --> 0:09:25.680 And obviously the government has a lot of capacity to help, 0:09:25.720 --> 0:09:28.079 and you know they've they've been applying stimulus the economy 0:09:28.080 --> 0:09:31.400 and all sorts of things. Ultimately, do we expect the 0:09:32.040 --> 0:09:36.600 government to backstop all these these local government financing vehicles 0:09:36.600 --> 0:09:38.480 and step in and help them. 0:09:38.520 --> 0:09:41.400 Definitely, And I think they have a lot of tools. 0:09:41.600 --> 0:09:46.920 For example, most China's biggest banks are stay owned. The 0:09:46.960 --> 0:09:50.640 government for example, could ask the state banks to start 0:09:50.840 --> 0:09:54.760 providing relief, like they can ask the banks to offering 0:09:55.520 --> 0:09:58.240 longer term loans to this iltf thisse. 0:09:58.720 --> 0:10:02.120 You mentioned the per els with the housing crisis. You know, 0:10:02.120 --> 0:10:06.640 there's been a lot of property developer distress, including Evergrand, 0:10:06.640 --> 0:10:09.360 which is a huge situation. I think it's the biggest 0:10:09.360 --> 0:10:12.000 distress debt situation in the world at the moment. In 0:10:12.000 --> 0:10:14.800 that situation, it seems like investors will take a loss. 0:10:14.800 --> 0:10:16.960 But do we do we expect investors to take a 0:10:16.960 --> 0:10:20.040 loss on this kind of debt, which is eventually essentially 0:10:20.160 --> 0:10:23.000 municipal debt. Do we do expect losses there for investors? 0:10:25.200 --> 0:10:31.280 Well, a sector buildout is impossible in a way because 0:10:31.600 --> 0:10:35.520 just because the amount of debt in this sector, it's 0:10:35.600 --> 0:10:44.880 something beyond the garments are leveled, of beyond the garment's 0:10:44.920 --> 0:10:50.840 ability to help. But also it's it involves the question 0:10:50.960 --> 0:10:55.560 of moral hazard, right because the sector buildout would be 0:10:56.880 --> 0:11:03.199 giving signals that the central garment is encourage this rackless 0:11:03.280 --> 0:11:08.360 risk taking behavior. So in order to curb that thinking, 0:11:08.600 --> 0:11:12.680 you kind of like can let people assume that state 0:11:12.760 --> 0:11:15.600 would always come to the rescue when since go wrong. 0:11:16.440 --> 0:11:18.120 And that's exactly what seems to have happened in the 0:11:18.120 --> 0:11:20.720 property crisis, which is still going on, as you've been 0:11:20.760 --> 0:11:23.640 writing a lot about. I'm interested also in the developer 0:11:23.720 --> 0:11:26.439 side of the Chinese debt story and what's going on there, 0:11:26.440 --> 0:11:29.160 because we've seen Wonder bonds dropped a lot this week, 0:11:29.160 --> 0:11:31.680 We've seen lots of other developers under a lot of strain. 0:11:32.559 --> 0:11:34.880 Is that crisis still going as well? 0:11:35.000 --> 0:11:39.400 Yeah, that's an ongoing crisis. A lot of attention has 0:11:39.480 --> 0:11:44.280 been paid to the July twenty third bound payment because 0:11:44.480 --> 0:11:48.240 that's bounds is assumed, you know, like it's gonna to 0:11:49.080 --> 0:11:53.920 make timely payments, and it was treated above nineties just 0:11:53.960 --> 0:11:58.520 a week ago, so investors do acpect it to make 0:11:58.600 --> 0:12:03.319 the repayment. But the surprise came when one that told 0:12:03.720 --> 0:12:08.040 creditors that it still has a two one hundred million 0:12:08.120 --> 0:12:13.600 dollars short shortfall on the maturing bound on Monday. So 0:12:13.840 --> 0:12:17.600 as soon as you know it told creditors news, the 0:12:17.679 --> 0:12:21.719 bound fell twenty two cents on the day and continue 0:12:21.800 --> 0:12:26.840 failing on qday. So I guess like now we're just 0:12:26.960 --> 0:12:31.360 like less than a week from that maturity date, but 0:12:31.480 --> 0:12:35.240 people are still not sure whether bunned up when that 0:12:35.320 --> 0:12:39.360 would make that payment. That's something everybody is watching now. 0:12:40.160 --> 0:12:42.520 Interesting, that's a that's another one like Evergham that has 0:12:42.520 --> 0:12:44.920 a lot of debt in dollars, so there will be 0:12:46.320 --> 0:12:49.280 you know, exposure from investors all over the world in 0:12:49.280 --> 0:12:49.600 that one. 0:12:49.679 --> 0:12:54.000 Yeah, correct, he does want to be a disimblant of China. 0:12:54.559 --> 0:12:54.800 Yeah. 0:12:55.120 --> 0:12:58.120 Yeah, so in both cases, I mean on the local 0:12:58.160 --> 0:13:01.280 government financing vehicle side that you've done so well explaining 0:13:01.559 --> 0:13:04.920 to us, there seems to be more of a domestic exposure, 0:13:04.920 --> 0:13:08.319 but to the property developers which in a similar mess 0:13:08.360 --> 0:13:13.480 there there is likely to be losses for bondholders all 0:13:13.520 --> 0:13:14.400 around the world. 0:13:14.920 --> 0:13:18.680 Yeah, that's it has a lot of global investors. 0:13:19.040 --> 0:13:21.240 So the longer term impact on this, I mean, I 0:13:21.240 --> 0:13:23.920 guess you know, we talked to investors here that that 0:13:24.000 --> 0:13:29.040 must affect risk appetite for Chinese bonds, particularly junk bonds, 0:13:29.080 --> 0:13:32.880 you know, which haven't performed particularly well this year. Is 0:13:33.240 --> 0:13:37.000 this all telling us that we should be much more vigilant, 0:13:37.200 --> 0:13:40.360 much more careful when it comes to Chinese credit risk. 0:13:40.760 --> 0:13:42.959 Yeah, and I think a lot of the investors are 0:13:43.120 --> 0:13:48.720 already start doing that, right. It's now like a lot 0:13:48.760 --> 0:13:53.320 of investors are choosing Chinese property bonds as they are 0:13:54.000 --> 0:13:58.280 a priority for investments. Some are saying, you know, like 0:13:58.400 --> 0:14:01.280 if went that word to fail to repay this bound, 0:14:01.440 --> 0:14:05.360 it will be another nail in the coffin for Chinese 0:14:05.440 --> 0:14:10.000 hio properly bounds. A lot of investors are training away 0:14:10.040 --> 0:14:15.760 from investments like that. Like another big Chinese developer, Country Garden, 0:14:16.120 --> 0:14:19.800 it's now having its bound treaty in the twenties or thirties. 0:14:20.280 --> 0:14:24.080 So that's suggesting people are not really having face about 0:14:24.400 --> 0:14:26.040 its own time repayment. 0:14:26.600 --> 0:14:29.600 And so before we talk to himanship actually bloom back intelligence, 0:14:29.880 --> 0:14:32.240 what's the next big thing to watch out for a 0:14:32.280 --> 0:14:35.080 way I mean we're talking about more maturities. Is there 0:14:35.120 --> 0:14:37.480 more distress coming? Is there anything else on your calendar 0:14:37.520 --> 0:14:38.360 that we should be aware of. 0:14:38.840 --> 0:14:42.360 I guess a lot of investors they are generally interested 0:14:42.440 --> 0:14:48.480 in the Chinese Chinese government's attitude about the property sector 0:14:48.560 --> 0:14:51.840 and the LDF sector because in China the state just 0:14:51.920 --> 0:14:56.960 plays the chin important role and if the government has 0:14:57.160 --> 0:15:03.240 more stimulus or subsidies given to this subsidies, we can 0:15:03.360 --> 0:15:09.080 really say a shift of attitude in investors investment, but 0:15:09.200 --> 0:15:11.800 don't chosen. I guess a lot of investors are just 0:15:11.920 --> 0:15:15.600 taking a wait and say attitude and say what's going 0:15:15.640 --> 0:15:19.480 to happen and what's the next stops, next steps that 0:15:19.600 --> 0:15:20.600 government is going. 0:15:20.480 --> 0:15:23.800 To take great stuff. Way Joe from Bloomberg News, thank 0:15:23.840 --> 0:15:26.600 you so much for joining us. Thank you important story. 0:15:26.640 --> 0:15:29.080 We should all be watching it wherever we are sitting. 0:15:29.520 --> 0:15:32.520 Read all of Waye's scoops on the Bloomberg terminal and 0:15:32.640 --> 0:15:35.840 of course at Bloomberg dot com. So, as I mentioned earlier, 0:15:35.960 --> 0:15:38.000 there's a lot going on in Canada right now, and 0:15:38.000 --> 0:15:40.240 we're very pleased to have with us him Manchu Bakshi, 0:15:40.240 --> 0:15:43.120 who covers the banking sector up there for Bloomberg Intelligence 0:15:43.320 --> 0:15:45.920 based in New York. How's it going, Hi Manchu. 0:15:45.920 --> 0:15:47.080 Hi Jims. Thank you for having me. 0:15:47.120 --> 0:15:49.240 How are you very well? Thanks? I know you're very 0:15:49.280 --> 0:15:51.800 busy with earnings at the moment, but as you've been 0:15:51.840 --> 0:15:54.240 writing about, there's a bit of a problem with housing 0:15:54.360 --> 0:15:56.080 right now, and I wonder if you could just walk 0:15:56.160 --> 0:15:56.600 us through that. 0:15:57.240 --> 0:16:02.920 Sure. So housing has always been a concern for Canadian banks. Recently, 0:16:02.960 --> 0:16:06.840 what we're seeing is because of higher rates on adjustable 0:16:06.920 --> 0:16:11.240 rate mortgages. We're seeing that because the mortiket rates are 0:16:11.280 --> 0:16:14.640 going up in twenty twenty five and twenty twenty six 0:16:14.720 --> 0:16:19.400 mortgage that will be due to renew those borrowers will 0:16:19.440 --> 0:16:22.560 be facing higher mortgage payments and that's a risk to 0:16:22.640 --> 0:16:23.680 banks asset quality. 0:16:24.440 --> 0:16:28.680 So those just find those are mortgages that are short 0:16:28.760 --> 0:16:31.480 term and they're coming up for a reset on the rates. 0:16:31.720 --> 0:16:34.480 That's that's right. So in Canada it's a little different 0:16:34.480 --> 0:16:36.920 than in the US. They have the mortgages in Canada 0:16:36.920 --> 0:16:39.560 have a contractual maturity of five year and amortization period 0:16:39.600 --> 0:16:44.520 of twenty five years, and most of the mortgages in Canada, 0:16:44.640 --> 0:16:47.240 or the adjustable rate mortgages, the way they work is 0:16:47.240 --> 0:16:50.920 their adjustable rate fixed payments, which means when market rates 0:16:50.960 --> 0:16:53.880 go up, the monthly payments don't go up immediately, they 0:16:53.920 --> 0:16:58.360 go up at the reset. And so right now, the 0:16:58.480 --> 0:17:03.600 concern is that all the mortgages that reset at a 0:17:03.640 --> 0:17:09.480 higher rate, they will squeeze borrowers. But that's only if 0:17:09.680 --> 0:17:13.320 we assume that rates will stay higher for longer. But 0:17:13.480 --> 0:17:19.360 on the positive side, we may see wage growth through 0:17:19.400 --> 0:17:21.920 twenty twenty five, twenty twenty six, so borrows should be 0:17:22.000 --> 0:17:23.439 able to absorb some of those pressure. 0:17:23.840 --> 0:17:27.720 But so rates, you know, since the Canadian consumers last, 0:17:27.800 --> 0:17:30.400 you know, when they first took out those mortgages, let's 0:17:30.400 --> 0:17:33.720 say five years ago, how how much higher have rates gone? 0:17:33.760 --> 0:17:35.760 I mean, how much is the mortgage in the customer 0:17:35.800 --> 0:17:36.520 right now in Canada? 0:17:36.560 --> 0:17:39.560 So right now it's over six point eight seven percent, 0:17:39.680 --> 0:17:42.560 because right now the overnight rate is now five percent, 0:17:43.320 --> 0:17:46.520 and all these borrowers, especially if you look at twenty eighteen, 0:17:46.560 --> 0:17:50.119 twenty nineteen, even early twenty twenty, they took mortgages are 0:17:50.200 --> 0:17:54.040 less than two percent now, all these borrowers were stress 0:17:54.160 --> 0:17:58.720 tested at five point two five percent at least, but 0:17:58.800 --> 0:18:01.639 again mortgage 'es are where above that. So if they 0:18:02.040 --> 0:18:04.840 if they have a reset date coming up, then those 0:18:04.880 --> 0:18:07.440 marketers will be reset higher and their mortgage payments will 0:18:07.480 --> 0:18:07.840 go up. 0:18:08.040 --> 0:18:10.280 And at the same time, housing prices have shut up, 0:18:10.320 --> 0:18:11.240 haven't they in Canada? 0:18:12.240 --> 0:18:14.320 I won't say shut up, but in recently what we 0:18:14.400 --> 0:18:18.840 saw since the Bank of Canada starting raising rates last March, 0:18:19.320 --> 0:18:23.080 we saw a decline in correction in housing prices. We 0:18:23.119 --> 0:18:27.400 saw a little optic in May after eleven months of decline, 0:18:27.840 --> 0:18:30.560 but we may see more correction because that was because 0:18:30.600 --> 0:18:33.119 the Central Bank actually stopped raising rates in chain. But 0:18:33.400 --> 0:18:35.880 we have seen two hikes since then, so we may 0:18:35.920 --> 0:18:39.480 see a little more correction through this year. 0:18:40.160 --> 0:18:42.480 So from the credit standpoint, we look at this more 0:18:42.520 --> 0:18:45.760 from the perspective of the banks. You know, the banking 0:18:45.800 --> 0:18:48.200 system in Canada is quite different. There's only a few 0:18:48.240 --> 0:18:50.520 of them and they're you know, they're pretty conservative and 0:18:50.520 --> 0:18:53.320 they're quite stable. But how much exposure do they have 0:18:53.359 --> 0:18:58.000 to this problem of the mortgage refi and the consumers 0:18:58.000 --> 0:18:59.240 coming under so much pressure. 0:18:59.520 --> 0:19:02.480 So the big five six banks in Canada actually control 0:19:02.520 --> 0:19:04.840 eighty to ninety percent of eighty percent of the lending 0:19:04.880 --> 0:19:07.680 and they hold eighty percent of the deposits, so their 0:19:07.720 --> 0:19:12.280 exposure to housing is about fifty percent. CIBC Canadian Imperial 0:19:12.320 --> 0:19:15.040 Bank of Commerce being the most exposed, and Bank of 0:19:15.119 --> 0:19:19.800 Montreal leased, so it's a pretty big significant exposure of 0:19:19.840 --> 0:19:20.879 their total portfolio. 0:19:21.560 --> 0:19:23.960 So when you say CIBC is most exposed, you think 0:19:24.080 --> 0:19:27.080 they're going to sustain substantial losses. 0:19:27.640 --> 0:19:30.760 So that's not our base case. So we think not 0:19:30.800 --> 0:19:33.920 just CIBC, but all Canadian banks have first of all, 0:19:33.920 --> 0:19:37.359 their highly profitable banks and so they have that earning 0:19:37.440 --> 0:19:40.840 scussion to absorb higher provisions if they need to. And 0:19:40.880 --> 0:19:43.959 then also the banks have been increasing their regulator has 0:19:43.960 --> 0:19:47.120 been increasing their capital requirements and therefore the banks are 0:19:47.240 --> 0:19:50.359 increasing their common equity of one capital, so they have 0:19:51.200 --> 0:19:54.280 good first line defense in the form of earnings, and 0:19:54.320 --> 0:19:58.760 they also have good last defense as their capital. So 0:19:58.800 --> 0:20:01.320 not just CIBC, all the bank should be comfortable. We 0:20:01.359 --> 0:20:03.639 actually stress tested all the banks at a five percent 0:20:03.720 --> 0:20:07.399 loss straight on their uninsured mortgage portfolio, and even though 0:20:07.400 --> 0:20:09.600 the capital ratios declined from where they were in two 0:20:09.720 --> 0:20:11.960 q but all the banks remain well capitalized. 0:20:12.280 --> 0:20:14.800 And to be clear, five percent is way more than 0:20:14.840 --> 0:20:15.640 anyone's expecting. 0:20:15.880 --> 0:20:18.560 It's way more than anybody's expecting. It's way more than 0:20:19.080 --> 0:20:23.000 we start during the nineteen ninety one housing downtown And 0:20:23.240 --> 0:20:25.840 just to give you an idea, when the Bank of 0:20:25.880 --> 0:20:29.399 Canada actually stress tested banks, they forecasted that the losses 0:20:29.440 --> 0:20:32.080 on their uninsured mortgages will be point seven percent? 0:20:32.560 --> 0:20:34.480 Are they being overly optimistic though at that point? 0:20:34.480 --> 0:20:39.719 Well maybe, But we tried to do a direct in 0:20:39.720 --> 0:20:41.720 our stress test analysis. We try to do like a 0:20:41.760 --> 0:20:44.119 dict head to capital, so we don't We didn't assume 0:20:44.160 --> 0:20:46.800 any capital management actions from the bank. It was just 0:20:46.880 --> 0:20:49.520 a point in time dict had to capital. Can the 0:20:49.560 --> 0:20:51.520 bank survive? And we think, yes they can. It will 0:20:51.520 --> 0:20:53.040 not be a capital issue, it will be earning this 0:20:53.040 --> 0:20:53.879 issue for the banks. 0:20:54.119 --> 0:20:56.040 And again from a credit standpoint, I mean, how do 0:20:56.080 --> 0:20:59.439 you position as an investor here and do you expect 0:20:59.720 --> 0:21:04.160 see IBC spreads to widely substantially versus comparables or how 0:21:04.160 --> 0:21:04.680 does that play? 0:21:04.800 --> 0:21:04.879 So? 0:21:05.280 --> 0:21:08.000 Yes, that's right. So because CIBC is most exposed if 0:21:08.040 --> 0:21:13.040 we see a larger than expected housing price correction, the 0:21:13.080 --> 0:21:16.680 bonds of banks which which are most more exposed to housing, 0:21:17.040 --> 0:21:21.840 like CIBC, will be sensitive to housing price correction. Again, 0:21:22.119 --> 0:21:24.840 our base cases not that we'll see a big drop 0:21:24.880 --> 0:21:28.080 in house prices because in Canada it's mostly a supply 0:21:28.200 --> 0:21:30.440 issue and so we don't see that happening. But if 0:21:30.480 --> 0:21:32.520 that happens, I think the bonds of CIBC will be 0:21:32.520 --> 0:21:34.359 more sensitive than all the other banks in Canada. 0:21:34.720 --> 0:21:37.960 And what does best in this scenario? I'm sorry which 0:21:38.000 --> 0:21:39.360 bank performs best in that. 0:21:39.320 --> 0:21:41.679 S so Bank of Montreal. If you're only looking at 0:21:41.680 --> 0:21:45.080 housing portfolio, Bank of Montreal has the least exposure. They 0:21:45.160 --> 0:21:48.280 also really big in the US, SO Bank of Montreal 0:21:48.280 --> 0:21:51.400 will be best position. And after that, I would say 0:21:51.440 --> 0:21:52.639 TD and RBC the two pick. 0:21:53.200 --> 0:21:54.679 You know, when I go up to Canada and I 0:21:54.840 --> 0:21:56.760 tend to go to run to more than other cities. 0:21:57.280 --> 0:21:59.679 There seems to have been for quite some time a 0:21:59.720 --> 0:22:02.119 lot of overbuilding. I mean, you say that there's a 0:22:02.160 --> 0:22:06.400 shortage of supply, but the overbuilding to me seems more 0:22:06.440 --> 0:22:11.000 on the office side, and the return to office has 0:22:11.040 --> 0:22:14.439 been slower in Toronto than other parts of you know, 0:22:14.480 --> 0:22:17.760 compared to New York for example. Is that not a 0:22:17.760 --> 0:22:21.080 big vulnerability for the banks that they that they're you know, 0:22:21.359 --> 0:22:24.840 may be more exposed on the commercial mortgage side than 0:22:24.880 --> 0:22:26.280 the reach sure. 0:22:26.400 --> 0:22:29.960 So overall commercial is about on average forty percent of 0:22:30.160 --> 0:22:33.480 banks loan poard for you overall, and specifically if you 0:22:33.520 --> 0:22:37.119 look at CIRI, that's about ten percent on average. But 0:22:37.240 --> 0:22:40.520 as you mentioned about offices, offices, office exposure is just 0:22:40.640 --> 0:22:44.000 one percent of their total one part. So it's a risk, yes, 0:22:44.040 --> 0:22:46.959 absolutely wide risk because if you look at office vacancies, 0:22:48.000 --> 0:22:51.000 that's highest in a decade. It was I think it 0:22:51.040 --> 0:22:53.080 was up eighteen percent in one Q. It's highest in 0:22:53.119 --> 0:22:55.600 a decade. So, yes, that's a concern, that's a risk, 0:22:55.640 --> 0:22:58.280 but that's a manageable risk because at one percent, we 0:22:58.400 --> 0:23:01.760 actually stressed us to the office exposure of all the 0:23:01.800 --> 0:23:05.840 banks and we found that actually their earnings can absorb 0:23:05.880 --> 0:23:08.320 the provisions if we assume a two percent loss rate 0:23:08.359 --> 0:23:09.520 on their office portfolio. 0:23:10.080 --> 0:23:11.720 Okay, so what are we looking for in terms of 0:23:12.160 --> 0:23:15.439 events key events? You mentioned the resets? You know, is 0:23:15.440 --> 0:23:18.760 there is there a particular maturity hump here in terms 0:23:18.760 --> 0:23:21.840 of the resets or is there some other some other 0:23:22.080 --> 0:23:24.840 event on the calendar that could trigger, you know, an 0:23:24.880 --> 0:23:27.359 unraveling of this in terms of defaults and mortgage is 0:23:27.359 --> 0:23:27.840 that sort of thing. 0:23:27.960 --> 0:23:31.720 I think the biggest uh factor that we're looking at 0:23:31.800 --> 0:23:34.800 is how high the rates will go, because one thing 0:23:34.880 --> 0:23:38.160 we I think I forgot to mention before that even 0:23:38.200 --> 0:23:40.400 though on all these adjusts to rate mortgages, your monthly 0:23:40.440 --> 0:23:42.760 payments don't go up immediately when rates go up. But 0:23:43.560 --> 0:23:46.520 if the rates go high enough that your monthly payments 0:23:46.560 --> 0:23:50.439 don't don't cover principle just interest, then it hits at 0:23:50.760 --> 0:23:53.240 what we call it a trigger rate, and then your 0:23:53.280 --> 0:23:55.720 monthly mortket you wan go up. So for us, though, 0:23:55.760 --> 0:23:59.000