Canada’s Strained Housing Markets

Derek HoltVice-President, Scotiabank Economics

March 7, 2013

Outline

1. Macro backdrop & the Bank of Canada

2. Canadian Housing:

a) Strains

b) Mitigating Factors

c) Why It’s (Somewhat) Different From the United States

d) Pockets Of Concern

The Macro Backdrop –

BoC On Hold Throughout 2013-14

-4

-3

-2

-1

0

1

2

3 %

Source: Bank of Canada, Statistics Canada, Scotia Economics.

Scotia's Output Gap

BoC's output gappost-GDP revision

Will Canadian Spare Capacity Narrow Or Widen?

Spare Capacity Will Prevent The BoC From Hiking Through 2013-14

Even The BoC’s Output Gap Doesn’t Go Into Excess Demand By 2014

Canada’s Current CPI Softness Could Be Returning Us To The Past

-1

0

1

2

3

4

5

6

7

8

90 91 92 93 94 95 96 97 98 99

US

Canada

CDN CPI: Back To The 1990s?

Source: Statistics Canada, BLS, Scotiabank Economics.

CPI, y/y % change

Among The World’s Best Corporate Balance Sheets

Source: Statistics Canada, Quarterly Survey of Financial Statements, Scotia Economics

2. Canadian Housing

a. The Strains

Canada Is At A Cycle Top In Housing

Source: Statistics Canada, Census of Population, U.S. Census Bureau, Housing Vacancy Survey, U.K. Office forNational Statistics, Census of Population, Australian Bureau of Statistics, Census of Population and Housing.

60

62

64

66

68

70

72

1991 1996 2001 2006 2011e

%

Home Ownership Rate

Canada

Australia

U.K.

U.S.

95

100

105

110

115

07 08 09 10 11 12Source: OECD, Eurostat, UK National Statistics, Scotiabank Economics.

Real consumer spending indexed to 2007Q1 = 100

Canada Is At An Exhausted Point In The Consumer Cycle

Canada

U.K.

US

Euro zone

Japan

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1971 1979 1987 1995 2003 2011

0

2

4

6

8

10

12

14

1971 1979 1987 1995 2003 2011

Source: MLS, Statistics Canada, Scotiabank Economics.

C$ bns, nsa, 4-quarter moving average

Canadian Renovation Spending

% of personal disposable income, nsa, 4-quarter moving average

Canadian Renovation Spending At A Record High

Sharply Cooling Canadian Housing Resale Markets

-40 -30 -20 -10 0 10 20

Vancouver*

Regina

Victoria*

Toronto*

Thunder Bay

Montreal

Halifax

Durham Region

Ottawa

Sudbury

Quebec City

Hamilton

Canada

25 Major Markets

London

Saskatoon

St. John’s

Calgary*

Kitchener-Waterloo

Saint John

Winnipeg

St. Catharines

Windsor

Edmonton

Canadian Resale Transactions

volume of transactions,

y/y % change, January 2013

Source: CREA, QFREB, Scotiabank Economics. *February data.

% share of mkt, Jan 2013

4.6

1.5

0.6

2.4

0.3

1.5

6.7

0.9

1.2

1.9

67.9

100.0

3.0

1.9

0.5

2.6

2.1

1.3

8.9

0.4

18.6

1.2

0.8

5.8

Canadian House Prices In Early Decline Phase

-10 -5 0 5 10 15 20 25 30

Saint John

Vancouver*

Ottawa

Kitchener-Waterloo

Victoria*

Winnipeg

Windsor

St. Catharines

Edmonton

Canada

Toronto*

25 Major Markets

Sudbury

Montreal

London

Saskatoon

St. John’s

Hamilton

Durham Region

Regina

Calgary*

Quebec City

Halifax

Thunder Bay

Canadian Home Prices

y/y % change, January 2013

Source: CREA, QFREB, Scotiabank Economics. *February data.0 50 100 150 200 250

Windsor

Thunder Bay

St. Catharines

London

Durham Region

Saint John

Victoria*

Kitchener-Waterloo

Canada

Toronto*

Hamilton

Ottawa

Sudbury

25 Major Markets

Halifax

Vancouver*

Edmonton

Calgary*

Winnipeg

Saskatoon

St. John’s

Regina

Canadian Home Prices

cumulative % change from December 1999

Source: CREA, Scotiabank Economics. *February data.

100

120

140

160

180

200

220

240

00 03 06 09 12

Canada – Teranet National Bank House Price Index

US – Case-Shiller Home Price Index

Source: Teranet National Bank House Price Index, S&P/Case-Shiller Home Price Index, Scotiabank Economics.

index:Jan 2000=100

Home Price Indices – Repeat Sales Metric

Canadians Have Higher Debt… But Stronger Balance Sheets

* Includes households, non-profits and unincorporated business.Source: U.S. Federal Reserve, Statistics Canada, Scotiabank Economics.

70

85

100

115

130

145

160

1990 1995 2000 2005 2010

Canada*

US

household credit liabilities as % of disposable income

Canadians’ Debt-To-Income Now Higher…

14

18

22

26

30

1990 1995 2000 2005 2010

Canada*

US

household debt as % of assets

… But Less Debt Used To Buy Assets

Canada’s Debt Service Burden Is At An All-Time High

Source: Bank of Canada, Statistics Canada, Scotia Economics.

0

5

10

15

20

25

30

1982Q1 1986Q1 1990Q1 1994Q1 1998Q1 2002Q1 2006Q1 2010Q1

Canada's Household Debt Service Burden

interest payments on all debt + mortgage principal payments (% share of after-tax PDI)

Source: Bank of Canada, Statistics Canada, Scotiabank Economics.

Principal

Interest

Total

Distorted by accounting change

No Leverage Apart From Household Debt? Think Again

• Condos have driven all of the rise in housing starts for years…

• …estimated 45-60% of Toronto of new condo sales over recent years have gone to investors not for primary occupancy….

• …5-15% down payments at sales office openings imply +/- 10 times gearing…

• …then flip when the project goes live

• Leveraged equity has been behind this

Will Canadian Housing Starts Follow Sales Like They Did In The US?

0

1

2

3

4

5

6

7

8

0.0

0.5

1.0

1.5

2.0

2.5

04 06 08 10 12

Source: U.S. Census Bureau, NAR, Scotiabank Economics.

unit millions

Housing Starts & Resales Declined Simultaneously in the U.S.

unit millions

Housing Starts (LHS)

Resales (RHS)

Scenarios For Housing Starts

100

120

140

160

180

200

220

240

260

05 06 07 08 09 10 11 12 13

Source: CMHC, Scotiabank Economics.

000s

Canadian Housing Starts

History

forecast

BaseCase

Risk

Weakest Household Debt Growth Since The 1990s…

0

2

4

6

8

10

12

14

16

18

20

90 92 94 96 98 00 02 04 06 08 10 12

Residential Mortgage Growth

Source: Bank of Canada, Scotiabank Economics.

%, 3-month moving average

y/y % change

m/m % change, seasonally adjusted

0

2

4

6

8

10

12

14

16

18

90 92 94 96 98 00 02 04 06 08 10 12

Household Credit Growth

Source: Bank of Canada, Scotiabank Economics.

%, 3-month moving average

y/y % change

m/m % change, seasonally adjusted

…Especially For Consumer Loans

-5

0

5

10

15

20

90 92 94 96 98 00 02 04 06 08 10 12

Consumer Loan Growth

Source: Bank of Canada, Scotiabank Economics.

%, 3-month moving average

y/y % change

m/m % change, seasonally adjusted

2. Canadian Housing

b. Mitigating Factors

After Ottawa Eased The Most Since 1954 NHA and 1967 Bank Act…

• 1999: Introduction of 5% down payment insured mortgage

• 2003: Price ceiling on insured mortgages lifted

• 2005: Introduction of insured mortgage with 30-year amortization period

• 2006: Introduction of insured mortgage with 35-year & 40-year amortization periods

• 2006: Introduction of 0% down payment insured mortgage

…CDN Macroprudential Rules Clamped Down

• After sharply easing mortgage lending standards in 2006-07, the federal government has since reversed its position

• October 2008: Max 35 year amortization for insured mortgages; minimum 5% down for insured mortgages; consistent minimum credit score; new loan doc standards for property value and incomes

• February 2010: Qualify at 5 yr posted rate instead of 3 yr; lower refi ceiling to 90% from 95%; min 20% down required to get mortgage insurance on non-owner occupied properties

• January 2011: Max 30 year amortization for insured mortgages; refi ceiling for primary occupancy homes dropped to 85% from 90%; withdraw gov’t insurance on HELOCs

• November 2011: Accounting changes to hold more on balance sheet

• June 2012: Max 25 year amortization for insured mortgages; insurance dropped for mortgages on homes valued over $1 million (ie: now minimum 25% down); refinancing ceiling dropped to 80% from 85%; mortgage payments and total debt payments capped at 39% and 44% of income respectively.

• 2012-13 Federal Budget: OSFI oversight of CMHC

• Spring 2012: Insurance lifted from covered bonds, portfolio caps at the CMHC, new OSFI lending guidelines to banks

• January 2014: Basel III

A key difficulty lies in evaluating the opaque forms of non-rules-based tightening being applied through moral suasion by regulators to lenders and GSEs.

Assessing Mortgage Rule Tightening

$362

$166

$0

$50

$100

$150

$200

$250

$300

$350

$400

40 down to 25 30 down to 25

Source: Scotia Economics.

Evaluating AmortizationCompression

Increase in Monthly Mortgage

Payments, $

10

20

30

40

50

60

70

00 02 04 06 08 10

Housing Starts

Single-detached

Good Reasons For Rising High-Rise Housing Demand?

% share of total

Source: CMHC, Scotia Economics.

Apartment

• Better affordability

• Favourable demographics

• Lifestyle choices

• More selection

• Urban renewal / intensification

• Tight rental vacancy rates

• Investor purchases

Canadians Have More Home Equity & More Real Estate in their Portfolio

Includes households, non-profits and unincorporated business.Source: U.S. Federal Reserve, Statistics Canada, Scotiabank Economics.

Canadians Have More Home Equity…

30

40

50

60

70

80

1990 1995 2000 2005 2010

Canada

US

Real estate equity as % of real estate assets

15

20

25

30

35

40

45

1990 1995 2000 2005 2010

Canada

US

… and More Real Estate Assets

Real estate as % of total household assets

2. Canadian Housing -

c. Why It’s (Somewhat) Different From The U.S.

• Explicit GSE guarantees – unlike the US GSEs

• Strongly capitalized banks & captive dealers, far less shadow banking

• Totally different funding model: deposit funding & large held-on-book component,

versus reliance upon revolving door financing

• Financial institutions less reliant upon short-term lines

• No strategic defaults, outside of Alberta & Saskatchewan (and limited there)

• Tougher bankruptcy rules

• Less outsourcing of sales force in Canada

• Generally more conservative products, but not entirely

• No option ARMs in Canada, but entire book resets within 5 years

• No mortgage interest deductibility (with exceptions)

• Stricter underwriting criteria including independent appraisals & hair-cuts

• Canada has already taken steps to tighten mortgage rules…

• …and is pursuing further financial reforms (Basel III, OSFI oversight etc)

What Makes Canada’s Mortgage Market Different?

Canadians Usually Don’t Default When House Prices Correct

Canada has witnessed some big price corrections since the late 1980s that corresponded with big shifts in the macro environment, notably in Toronto and

Vancouver, and yet each time mortgage arrears barely budged.

Implication? Revenues are at greater risk than charge-offs.

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Toronto 1989-95

Vancouver1990-91

Vancouver1995-96

Vancouver2008

Toronto 2008-09

peak to trough change in provincial mortgages in arrears, bps

Mortgage Arrears During House Price Corrections

Source: Canadian Bankers Association, Scotia Economics.

-30

-25

-20

-15

-10

-5

0

Toronto 1989-95

Vancouver1990-91

Vancouver1995-96

Vancouver2008

Toronto 2008-09

% change

Large House Price Corrections

Source: CREA MLS, Scotia Economics.

trough to peak in provincial mortgages in arrears, bps

2. Canadian Housing –

d. Pockets Of Greater Concern

Canadian Households More Heavily Leveraged Than Most

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Q1-12

Under Construction

Existing Condo Stock

Toronto Condo Construction:97k Units on the Way

Source: Urbanation, Scotiabank Economics

Toronto Condo Investors Under Water

Assumptions:• 20% mortgage down payment;

• 25 year amorization in 2004-05, 30-year am. from 2006-Q2 2012, 25-year am. from Q3 2012 onwards;

• Mortgage is fixed rate @ 3.5% from from 2009 onwards, 5% beforehand;

• Property taxes = 1% of condo purchase costs; maintenance & condo fees = $250/month;

• The 'shrinking new condo' starts at 650 Sq. Ft. in Q4 2004 and 'shrinks' 10 sq. ft. per year to reflect falling condo sizes;

• The shrinking codo's cost = its size * Urbanation's average $PSF condo cost estimate.

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

Q42004

Q42005

Q42006

Q42007

Q42008

Q42009

Q42010

Q42011

Q12012

Q22012

Q32012

Q42012

700 Sq. Foot Condo (Resale) Carrying Cost

Central Toronto 1-Bdrm Condo Rent

700 Sq. Foot Condo (New) Carrying Cost

Toronto Condos: Monthly Rent vs. Monthly Carrying Cost

Sources: MLS, TREB, Urbanation

Toronto’s Luxury Condos Adding To The Overhang

Trump International

Hotel & Tower

Shangri-La Toronto

Four Seasons Private Residences

(East & West Towers)

Residences at the Ritz-Carlton

Opening Date: January 2012 August 2012 Summer 2012 April 2011

• 65 storeys

• 118 residential units

• 261 hotel rooms

• 66 storeys

• 202 hotel rooms

• 287 residential units

• 55 storeys

• 253 hotel rooms

• 103 residences

• 25 storeys

• 101 residences

• 53 storeys

• 267 hotel suites

• 159 condo units

Source: Andrew Barr/National Post, THERESIDENCESTORONTO.COM, TRUMPTORONTO.CA, SHANGRI-LATORONTO.COM, YORKVILLERESIDENCES.COM.

Contacts

Economics 

Derek Holt, Vice-President, Scotia Economics

derek.holt@scotiabank.com

Dov Zigler, Financial Markets Economist

dov.zigler@scotiabank.com

 

 

 

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