Canada’s largest bank is prepared for price drops most would find unthinkable. Royal Bank of Canada (RBC) filings show possible risk scenario forecasts. Over the next year, the base forecast shows virtually flat growth. In a best case scenario, growth would hit levels similar to previous years. In a worst case, they forecast prices can make the biggest drop since the early 1980s.
Macroeconomic Scenario Assumptions
Quick intro to IFRS 9 macroeconomic assumptions for people that aren’t in finance, or aren’t secret finance nerds. IFRS 9 is a financial reporting standard used by most of the world’s banks at this time. One of these standards requires an assessment of risk, using unbiased and possible economic outcomes. Typically three macroeconomic scenarios are used: a base, best, and worst case scenario.
The base, best, and worst cases are what they sound like. The base case is the average scenario you currently expect. The best case is an ideal projection, if everything is perfect. The worst case is the most severe outcome you can realistically expect. The organization needs to be ready for each one of these scenarios.
The forecast numbers are important for each organization’s preparedness. Too optimistic, and just a few impairments can result in serious damage. Too negative, and you’ll be putting aside way too much capital, placing a drag on company growth. These aren’t just random numbers, they’re considered reasonable outcomes. That said, let’s look at their real estate scenarios.
Base Case: Canadian Real Estate Prices Are Flat
The base case isn’t as ambitious as most would guess, and it’s actually quite modest. The bank’s forecast sees prices rising 0.6% over the next 12-month, with the numbers starting in October. They expect compound annual growth of 4.5% for the following 2 to 5 years. Basically, they see the market as flat in this scenario.
RBC’s Canadian Real Estate Risk Scenarios
RBC’s macroeconomic scenario assumptions for Canadian real estate prices under various risk scenarios. Source: RBC, CREA, Better Dwelling.
Best Case: Canadian Real Estate Prices Rise 6%
The best case sees lower price growth than we’re currently seeing, but not far off. This ideal scenario would see home prices jump 6.1% over the next 12 months. That would be followed by compound annual growth of 11.1%, which is pretty big. It just might not seem huge in comparison to the past few years.
Worst Case: Canadian Real Estate Prices Fall Almost 30%
The worst case scenario is much larger than most banks have acknowledged, but is similar to Moody’s worst. The bank forecasts a national price drop of 29.6% over the next 12 months in this scenario. Compound annual growth of about 2.9% would follow in the next 2 to 5 years. Canada hasn’t seen such a significant decline at the national level since the early 80s.
Earlier this month, RBC’s chief risk officer said he was putting more weight on the downside scenario. However, he didn’t use the 29% price decline seen in this economic risk forecast. Instead he said they expect prices to fall around 7%, and remain depressed until late 2023. Reading between the lines, it sounds like they are internally forecasting a worse than expected outcome, but not the worst scenario they’ve prepared.
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