Canada Banks Tighten Condo Lending Amid Bubble Fear: Mortgages

Canada’s biggest banks are tightening lending standards for condominium builders at the urging of regulators, requesting higher pre-sales and deposits as policy makers warn the Toronto and Vancouver markets are overheating.

Some banks have been asking construction firms to put more equity into new projects in recent weeks, according to developers. Lenders have also been raising the percentage of condo units that must be pre-sold and are demanding higher deposits as conditions for financing, they said.

“Several of the banks have tightened up” after the Office of the Superintendent of Financial Institutions “told the banks to be a little bit more careful on who they are lending to and how they are lending,” said Barry Fenton, chief executive officer of Toronto-based Lanterra Developments, whose condos include WaterParkCity and Ice Condominiums at York Centre.

Policy makers including Finance Minister Jim Flaherty have warned about the risks of record consumer debt and soaring housing prices that some investors say may be inflating a condo bubble in Toronto and Vancouver. Housing prices may drop 15 percent as interest rates rise, crimping economic growth and sending Canadian stocks down 10 percent, said Sadiq Adatia, who manages about $9 billion at Sun Life Global Investments Inc.

While OSFI, Canada’s banking regulator, hasn’t imposed new formal requirements on real-estate lending specific to geography or property type, it increased supervision of residential lending practices more than a year ago, spokeswoman Leonie Roux said.

Risk Drivers

“This includes meeting with market participants to understand the drivers of risks and the decisions that are being made to manage those risks,” she said in an e-mail.

OSFI released new draft guidelines on March 19 for mortgage underwriting by Canadian financial institutions. Banks should take “reasonable steps” to verify a borrower’s income before granting mortgages, the agency said. Financial institutions should also establish internal standards on the ability of borrowers to service their debt.

“What we have seen is a little tightening of the requirements” on loans offered by major Canadian banks to condominium developers, said Dov Meyer, CEO of Terra Firma Capital Corp., (TII) a Toronto-based company that finances residential projects.

The condo building surge is being led by developers ranging from Toronto-based Tridel Group and Vancouver-based Concord Pacific to El-Ad Canada Inc. Toronto has more skyscrapers and high-rises under construction than any North American city -- almost three times as many as New York.

Record Debt

Rising home sales and prices fostered by the lowest interest rates in decades have pushed household debt to record levels, leaving some families vulnerable to an expected rise in borrowing costs. Flaherty and Bank of Canada Governor Mark Carney have warned Canadians to make sure they can afford their debts at higher interest rates.

Banking regulators have been monitoring the risk to financial institutions of the surging condo markets, especially in Toronto and Vancouver, OSFI documents released to Bloomberg News in January through freedom-of-information law show.

“The Toronto market is dominated by a small number of very powerful developers,” OSFI stated in a June 2011 market update. “Their role in supporting or discouraging pre-sale speculative activities would appear to be very inconsistent, with little transparency.”

‘Shut Door’

Some of the country’s biggest banks have “shut the door” on lending to less established real-estate developers, said Brad Lamb, president of Brad J. Lamb Realty Inc., which specializes in developing condos and loft apartments in Toronto, including the King East project on Parliament and King Streets.

“What I’ve been told, and I’ve had meetings with several banks in the last few weeks, is that OSFI has been in there, they’ve been clear about their concern about potential risks in the high-rise industry in Toronto and Vancouver, and that there needs to be a tightening,” Lamb said in a phone interview.

Less well-established companies may have difficulty getting loans from the top Canadian banks, even if they have pre-sold 70 percent of the units, collected 20 percent of the total purchase price in deposits, and can offer 15 percent of the project’s value in equity, Lamb said.

Efforts by federal regulators to slow the condo market will prove fruitless, since smaller developers should still be able to tap “tier-two” lenders and foreign institutions for capital, he said.

Raise Rates

“It’s not like we’re not going to have funding for our projects,” said Lamb. “If you want to cool the market, raise interest rates.”

Flaherty said yesterday banks can tighten rules for mortgage lending on their own and shouldn’t rely on the government to act for them.

“I’d like the market to correct itself,” Flaherty told reporters. “We’re seeing some evidence of that in the condo market, particularly in Toronto, where there is some softening of the market. And that’s a good thing.”

Canada’s banks have been ranked the soundest in the globe by the World Economic Forum in part because they avoided the subprime loans that crippled many U.S. lenders during the financial crisis. Canada’s 10-member S&P/TSX Banks Index (STBANKX) returned 155 percent over the past three years, compared with a 97 percent gain for the 24-member U.S. KBW Bank Index.

Aligned With Developers

Bank of Montreal (BMO) Chief Executive Officer William Downe said he can’t comment on conversations with OSFI. Still, developers are becoming more “conservative with respect to their projects, recognizing what’s going on in the market,” he said.

“I met with one of the largest developers in the last couple of weeks, and I was really impressed with how aligned we are,” Downe said in a March 20 interview in Halifax, Nova Scotia. “It’s not in their best interest to have a market that overheats and then falls rapidly.”

Toronto-Dominion Bank hasn’t made any recent changes to its lending practices to condo developers, said spokesman Stephen Knight. Royal Bank of Canada (RY) spokeswoman Ka Yan Ng declined to comment and Canadian Imperial Bank of Commerce spokesman Sean Hamilton didn’t return requests for comment. Bank of Nova Scotia (BNS) spokeswoman Ann DeRabbie reiterated comments the company made on a March 6 earnings call that its condo loans are performing well.

Mortgages on condos represent less than 8 percent of Royal Bank’s residential mortgage portfolio, Chief Risk Officer Morten Friis said on a March 1 earnings call. Royal’s exposure on loans to high-rise condominium builders is C$800 million, less than 3 percent of Royal Bank’s commercial-loan book, Friis said.

Vulnerable

“There may, for instance, be some vulnerability in the condo markets of Vancouver and Toronto, but as I have said before, we have very limited exposure to these markets,” Royal Bank CEO Gordon Nixon said on the call.

Toronto-Dominion Bank (TD) takes a “conservative” approach to loans to condo developers, which represent one of the “higher risks” in commercial lending, TD Chief Risk Officer Mark Chauvin said on a March 1 earnings call.

“Canadian banks are definitely” tightening standards on condos, said Adatia, chief investment officer at Sun Life Global in Toronto. “Canadians are looking at it and saying ‘we saw what the U.S. went through.’ The financial system in Canada is smarter than in the U.S.”

Flaherty said as recently as March 5 he is concerned some condominium markets are overheated and some families are taking on debts that will become unaffordable as interest rates rise. The central bank said March 8 household debt “remains the biggest domestic risk” and Carney said in a June speech in Vancouver there may be an “overshoot in the condo market in some major cities.”

Household Debt

The ratio of household debt to disposable income declined to 152.9 percent in the October-to-December period from a revised record 154.2 percent in the previous three months as income rose faster than borrowing, Statistics Canada said March 15.

Multiple-unit starts in Toronto more than doubled in January to 2,999 units compared with a year before, while starts rose 4 per cent in Vancouver to 1,261 units, according to Canada Mortgage & Housing Corp.

“The large number of construction cranes crowding Toronto’s skyline is raising concern of an emerging oversupply of high-rise housing,” Bank of Nova Scotia economist Adrienne Warren said in a March 16 research note. Slowing price appreciation should “dampen investor demand and new product launches,” she said.

Foreign Banks

Several prominent condo projects in the city have recently relied on financing from lenders other than the nation’s five largest banks. The Trump International Hotel & Tower Toronto opened in January with condo prices as high as C$6.3 million. The owner and developer, Talon International Development Inc., arranged C$310 million in construction financing from Raiffeisen Zentralbank Oesterreich AG, an Austrian bank.

Tricon Capital Group Inc. (TCN), a Toronto-based company that finances real-estate developments, is helping to finance a condo high-rise called Massey Tower in the city’s downtown theater district.

Paris-based BNP Paribas (BNP) SA says it has become one of the biggest providers in Ontario for condominium construction financing insured by CMHC. The bank says it has financed condominium construction loans for some of the country’s biggest developers, including Tridel and Lanterra. BNP helped finance the L Tower, a 57-story condominium designed by Daniel Libeskind under construction near Yonge and Front streets in Toronto.

“The smaller, medium-sized guys, those are the ones being asked for either higher presale targets to be hit and/or for their purchasers to come up with higher deposits,” said Tasso Eracles, CEO of Simerra Property Management in Toronto, which manages about 280 condominiums and is a unit of FirstService Corp. (FSRV)

To contact the reporter on this story: Andrew Mayeda in Ottawa at amayeda@bloomberg.net; Greg Quinn in Ottawa at gquinn1@bloomberg.net.

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net; David Scanlan at dscanlan@bloomberg.net.

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