Canada is not going to see a U.S.-style housing market meltdown: CIBC

Canada is not going to see a U.S.-style housing market meltdown: CIBC 
Prices likely to drop but Canadian market very different than that of 
pre-crash U.S. 
TORONTO, Oct. 30, 2012 /CNW/ - Canada is not poised for an American-style real 
estate meltdown, finds a new report from CIBC World Markets. 
The report notes that while there are a number of factors that raise concerns 
about Canada's housing market, there are fundamental differences between the 
Canadian and U.S. markets that should see a soft landing for the real estate 
market here. 
"To be sure, house prices in Canada will probably fall in the coming year or 
two, but any comparison to the American market of 2006 reflects deep 
misunderstanding of the credit landscapes of the pre-crash environment in the 
U.S. and today's Canadian market," says CIBC Deputy Chief Economist Benjamin 
He notes that while the debt-to-income ratio in Canada just broke the American 
record set in 2006, "this ratio is more a headline grabber than a serious 
analytical tool. There is a list of countries with comparably higher 
debt-to-income ratios, which did not experience anything remotely resembling 
the recent U.S. experience." 
Mr. Tal says we should pay more attention to the speed at which the 
debt-to-income ratio is growing. "Here the picture looks a bit less alarming. 
Comparing the three years heading into the U.S. crash to the past three years 
in Canada reveals that the debt-to-income ratio in Canada has been rising at 
half the speed seen in the pre-crash U.S. market." 
The strong growth in indebtedness south of the border was partially fueled by 
speculative activity in the housing market - something we've seen far less of 
in the Canadian market. In the decade leading to the crash, housing starts in 
the U.S. exceeded household formation by nearly 80 per cent. On average, over 
the past decade, the gap in Canada has been only 10 per cent—with most of 
the excess seen in cities such as Toronto and Vancouver. 
Another key difference between Canada and the U.S. is in the quality of 
mortgages. The distribution of credit scores has not changed dramatically in 
the past four years in Canada which is a very different story to what happened 
in the U.S. during the four years heading into the recession. Stateside, the 
proportion in the risky category rose by more than ten percentage points and 
accounted for 22 per cent of the overall market. 
But credit score does not tell the whole story says Mr. Tal. He notes that 
many of the troubled mortgages in the U.S. were sold to borrowers with an 
acceptable credit score but who did not satisfy the underwriting rules for 
prime loans because they were unable or unwilling to provide full 
documentation on their mortgage applications. In 2006, these non-prime 
mortgages accounted for no less than 33 per cent of originations and close to 
20 per cent of outstanding mortgages. 
"An astonishing one-third of mortgages taken out in 2005 and 2006, before the 
drop in prices, were in negative equity position, and no less than half had 
less than five per cent equity, making them highly exposed to even a modest 
decline in prices," adds Mr. Tal. "In Canada, the negative equity position is 
nil, and only 15-20 per cent of new originations have an equity position of 
less than 15 per cent. Furthermore, we estimate that the non-conforming market 
is currently at around seven per cent of mortgage outstanding, up from five 
per cent in 2005 but dramatically below the over 20 per cent seen in the U.S. 
at the eve of the crash." 
The report notes that, at its core, the U.S. meltdown is a non-conforming 
story. Average house prices in cities with above-average non-conforming 
exposure fell by 40 per cent from the June 2006 peak—double the decline in 
cities with below average exposure. "Eradicate subprime from the U.S. housing 
market and, instead of the most severe house price meltdown since the great 
depression, you get a soft landing," states Mr. Tal. 
In the U.S., a mortgage was typically 30 years compared to a 5-year term in 
Canada. Traditionally, this made Canadian borrowers more sensitive to the 
impact of interest rate hikes. In Canada today, borrowers are already curbing 
their rate sensitivity by reducing the share of variable rate mortgages in new 
originations to a multi-year low (mainly among more risky mortgages). 
"In the pre-crash U.S., the opposite was the case with the share of adjustable 
rate mortgages (ARM) staying elevated until the bitter end, with no less than 
80 per cent of non-conforming originations being ARMs," he adds. "And those 
mortgage gymnastics did not end here. The introduction of the teaser rate, a 
low introductory rate for a period of two or three years that would adjust 
upward at the end of the initial period, worked to effectively neutralize U.S. 
monetary policy. 
He notes that between mid-2004 and mid-2006, the Fed Funds rate rose by more 
than 400 basis points, but in part due to the impact of the teaser rate, the 
effective mortgage rate rose by only 30 basis points. The practical 
implication of that was that when the teaser period expired, millions of 
Americans felt the full impact of two years' worth of monetary tightening 
virtually overnight. 
"The reset of no less than $2 trillion of mortgage debt in 2006 and 2007 was 
no doubt the trigger to the U.S. housing crash. Such a potential trigger does 
not exist in Canada with mortgage rates likely to rise gradually, allowing 
borrowers to adjust over time." 
Mr. Tal notes that not all is well in the Canadian housing market. Home prices 
are overshooting their fundamentals, mainly in large cities such as Toronto 
and Vancouver and the recent slowing in sales activity will probably be 
followed by price adjustments in many cities across the country. 
"But the Canada of today is very different than a pre-recession U.S., namely 
as far as borrower profiles are concerned. Therefore, when it comes to jitters 
regarding a U.S.-type meltdown here at home, the only thing we have to fear is 
fear itself." 
The complete CIBC World Markets report is available at: 
CIBC's wholesale banking business provides a range of integrated credit and 
capital markets products, investment banking, and merchant banking to clients 
in key financial markets in North America and around the world. We provide 
innovative capital solutions and advisory expertise across a wide range of 
industries as well as top-ranked research for our corporate, government and 
institutional clients. 
Benjamin Tal, Deputy Chief Economist, CIBC World Markets Inc. at (416)  
956-3698, or Kevin dove, Communications and Public 
Affairs at 416-980-48358, 
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CO: CIBC World Markets
ST: Ontario
-0- Oct/30/2012 12:00 GMT
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