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
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
"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.
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
"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
The complete CIBC World Markets report is available at:
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Benjamin Tal, Deputy Chief Economist, CIBC World Markets Inc. at (416)
956-3698,email@example.com or Kevin dove, Communications and Public
Affairs at 416-980-48358,firstname.lastname@example.org.
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-0- Oct/30/2012 12:00 GMT
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