Month: June 2020
Household debt growth outstripping all other debt types
Over the last few decades, household debt growth accelerated faster than every other debt class, according to real estate information portal Better Dwelling.
Citing data from the Bank of Canada, the analysis said that the trend “makes Canadian households [among] the most vulnerable” globally.
“In 2000, household debt was just 58% of GDP. By the end of 2019 Q4, that number has hit 100% of GDP,” Better Dwelling said. “This is amongst the highest of advanced economies.”
BoC numbers indicated that national household debt hit a peak of $2.28 trillion in March, increasing by 0.44% from February and 4.6% from March 2019. Outstanding mortgages accounted for $1.64 trillion of this sum, rising by 0.49% monthly and 5.3% annually.
The impact on monthly budgets was inevitable: Even before the COVID-19 pandemic took hold, Canada’s insolvency incidence was already at 11,575 filings as of February, which was the highest level since 2010.
The Office of the Superintendent of Bankruptcy Canada said that this volume was 9% higher on an annual basis. Ontario posted the greatest increase during that month, at 3,837 filings (up 16.8% year over year), with Quebec’s 3,770 filings (up 1.9% annually) coming in at a close second.
“[These figures] underscore how vulnerable Canadian households are to income interruption. Over the next few months we’ll likely see an unfolding of two crises: the global pandemic and the bursting of the Canadian consumer debt bubble,” MNP LTD president Grant Bazian said. “Many households were already limited in their ability to face any kind of financial disruption. Now, all Canadians are feeling the effects on their paycheques, pocketbooks and stock portfolios. Those who were already saddled with a lot of debt are in economic survival mode.”
Economic Recovery to be “Prolonged and Bumpy,” Says BoC’s Macklem
He Also Defended Inflation Targeting and Reiterated Negative Interest Rates Are Unlikely
Report says housing market is due for a crash
The report “Canada on thin ice as it heats up” by Macro Research Board (MRB) partners paints a bleak picture. The report says that Canada has followed global trends in falling into a ‘sudden stop’ recession with high unemployment and a plunge in activity. It says that Canada is more exposed than most economies, however, because of “an unstable real estate bubble and household credit binge.” It says policymakers are putting off the day of reckoning but have run out of ammunition and there is no guarantee they can prevent a housing bust. The report says such a correction will have long-term positive effects in creating more caution among Canadian consumers, the short to medium term will be a rocky road to recovery.
“The Canadian economy has been increasingly driven over the past decade by the real estate boom and debt-fueled consumption binge,” The report reads. “In turn, a substantial housing and credit bubble has developed on the back of overly accommodative policy. We previously identified Canada as a candidate for a future housing downturn and deleveraging cycle but had noted that there was a lack of a sufficient adverse catalyst to bring these imbalances home to roost3. That all changed this year. The heightened uncertainty caused by the surge in unemployment and plunge in household confidence may encourage many Canadians to reconsider stretching beyond their means heading forward.”
While the report notes that the Canadian government is aggressively attempting to prevent a major deleveraging cycle, if it does develop it may prove to difficult and costly to stop. They say most indices they’re watching, such as upticks in shopping or downturns in the amount of time Canadians are spending at home, don’t point to a surging restart in the Canadian economy.
Unemployment surging is, according to MRB partners, a “massive headwind” for Canada’s housing market. While low rates and stimulus are helpful, if job losses prove sticky during the reopening there’s a risk of a crash in the market. MRB’s analysts say Canada needs a V-shaped recovery to avoid such a crash.
Underlying this issue, according to the report, is a decade of surging property values and a deterioration in household balance sheets, with many Canadians now living in massive levels of consumer debt. Despite aggressive support policy, MRB says the housing bubble they see is set to burst, though they are closely watching activity as restrictions on viewings ease.
The report doesn’t make a regional breakdown of Canadian housing numbers, but does raise the concern that supply was already beginning out outpace demand before the pandemic. Unsold inventories have been surging over the past two years, at levels close to housing crash of the early 90s. As builders get back to work earlier than much of the general economy, the record levels of construction in cities like Toronto pose a risk of glutting the market.
MRB’s report says that emergency measures like CERB, the wage subsidy, and the deferral of mortgages, all risk compounding the problem. If they’re allowed to run out at a certain time and the economy fails to make a rapid and stark restart, MRB is highly concerned about the possibility of a “deferral cliff.”
“Extreme fiscal policy efforts are providing temporary support but it will prove difficult for Canadian policymakers to prevent a material housing fallout, unless the domestic (and global) economy experience a V-shaped recovery and soon restore employment to pre-shutdown levels (which we are not expecting),” the report reads. “Substantial oversupply and the lack of valuation support are major problems at a point when the housing market faces new and powerful headwinds. When homeowners are stretching to buy, they need to believe that their jobs are secured (and wages will increase) and that their home value will continue to appreciate. If these conditions are threatened (which is now the case), it can quickly weaken confidence and housing demand, causing prices to fall substantially. This was last seen in the U.S. and parts of Europe during the late-2000s. Canada is now at the cusp of heading down this path if employment and job security do not rebound strongly and shortly.”
Home Sales & Prices Won’t Fully Recover Until 2022, Says CMHC
Conference Board releases mid-term outlook for Canadian real estate, economy
In what the Board is calling the “deepest and shortest recession on record”, Canada’s economy is expected to contract by 8.2% in 2020. According to Conference Board chief economist and contributor to the Outlook, Robin Wiebe, that puts the COVID-19 recession miles beyond past downturns. From the second quarter of 1976 until the end of 1982, GDP fell by almost four percent. It fell 2.3 percent between Q3 1987 and the second quarter of 1991. The recession associated with the 2007 financial crisis saw GDP growth shrink by 3.3 percent.
“It is pretty stark, there’s no question about that,” says Wiebe of the contrast.
The Board’s projections, however, are far from pessimistic. After adding almost 300,000 new positions in May, the job market is expected to maintain some sense of momentum over the next year-plus. Unemployment is expected to peak at 13.7 percent in the second quarter of 2020, but once another 1.3 million jobs are added in the third quarter, unemployment will start returning from its brief sojourn to the stratosphere. Unemployment is expected to remain above seven percent until late 2021. The rebound in hiring is expected to be more pronounced in industries such as financial services, professional services, manufacturing, and construction.
International trade is expected to be devastated by COVID-19, with export volumes falling by 14.3 percent and imports falling by 13.8 percent this year. Neither sector is expected to grow by more than eight percent in 2021. No surprise, then, that business investment is projected to decline by 11.3 percent in 2020.
Canadian housing in 2020 and 2021
When it comes to housing, the Conference Board appears to be far more optimistic than CMHC. Whereas CMHC has said home prices may fall by as much as 18 percent following COVID-19, the Board is projecting a possible decline of 11 percent in the average existing home price between the first and third quarters of 2020. But because of raucous pre-COVID buying activity, the Board is predicting a drop in the average resale price of only 1.6 percent this year and 2.1 percent in 2021.
“I think we might be a little more optimistic on the employment front,” than CMHC, Wiebe says, adding that the Board sees economic growth starting up earlier than CMHC, as well.
There will still be considerable discomfort for borrowers and prospective buyers. Travel habits aren’t expected to recover until late 2021, which is an awfully long time for the owners of short-term rental properties to survive without the above-market rents they (and their lenders) have come to depend on. CMHC’s new guidelines around borrowing, set to be implemented on July 1, will push untold numbers of first-time home buyers further to the sidelines. Housing starts are expected to drop precipitously, as well, meaning the buyers who remain in the market will inevitably be paying more for their properties.
But Wiebe is confident in the market’s ability to weather the storm.
“I do believe that the overall housing market is going to be strong in the medium-term,” he says. “Housing starts have been below household formations for seven of the eight years going into 2019, so there is pent-up demand.” If the economy rebounds “relatively decently” through 2020 and 2021, Wiebe says local housing markets should regain their strength by 2023 or 2024.
It’s important to note that the Conference Board’s projections are based on a number of assumptions, including:
- Canada avoids a second severe outbreak of COVID-19 that shuts down the economy
- A vaccine is made widely available to Canadians by June 2021
- The Canada Emergency Response Benefit winds down in October and funds shift toward the Canadian Emergency Wage Subsidy until a vaccine is available
- Canada returns to announced federal targets for international immigration in 2022
That’s a lot for people to hang their hopes on. As has been seen in the U.S. over the last two weeks, weak social distancing practices can quickly pull communities back into the COVID-19 quagmire. For Canada’s economy to rebound in a significant, continuous manner – more jobs, more investment, more spending by Canadian consumers – mitigating the spread of COVID-19 is a must. Otherwise, the Conference Board’s projections of economic growth, along with the hopes of 37 million Canadians, will need to be downgraded significantly.
Reduced selling will propel post-COVID-19 recovery – TD Economics
A vital component of the Canadian housing sector’s post-coronavirus recovery phase is homeowners refraining from selling their assets, according to TD Economics.
“Absolutely key to our forecasts is the assumption that listings mirror sales by dropping substantially in the near term and recovering gradually thereafter,” said TD economist Rishi Sondhi. “This puts a floor on prices and sustains relatively tight supply-demand balances across most markets, allowing for the resumption of positive price growth as provincial economies are re-opened.”
Such estimates have to be tempered by the reality of dwindling budgets forcing some homeowners to sell in a suboptimal market environment, however.
“Indeed, we anticipate the gap between listings and sales to grow in coming months, as financial stresses force some homeowners to list their properties,” Sondhi said.
Sales fell by 14.3% month-over-month, while new listings declined by 12.5% during the same period, according to March data from the Canadian Real Estate Association.
“At the national level, resale home prices were still gaining momentum in March. But this is based on home sales reported in land registries,” Teranet said. “The most important real estate boards all mentioned a clear break of activity during the second half of March due to measures to contain propagation of COVID-19.”
On the other hand, homeowners might find a measure of relief in “a jobs market that will likely improve starting next month,” Sondhi said. “Next year should see much stronger activity, as markets benefit from significant pent-up demand and historically low interest rates.”
New CMHC measures target most first-time home buyers
He also mentioned CMHC was evaluating whether it should change its underwriting policies in light of market conditions.
The evaluation period ended last week, with the announcement that, effective July 1, new measures will be in place for new applications for homeowner mortgage insurance for those with less than a 20 percent downpayment.
In a release, CMHC said the new measures are “Limiting the Gross/Total Debt Servicing (GDS/TDS) ratios to our standard requirements of 35/42; establish a minimum credit score of 680 for at least one borrower; and non-traditional sources of downpayment that increase indebtedness will no longer be treated as equity for insurance purposes.”
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If those terms are unfamiliar, here’s what they mean.
“When the math is done, this will reduce buying power on average by 10 percent,” says Mark Herman of Mortgage Alliance. “The lower-income earners are hit harder as a byproduct of how the math is done, which is most of the first-time home buyers.”
Preventing first-time home buyers from getting into ownership could strangle the home-building industry, said Kevin Lee, CEO of the Canadian Home Builders’ Association (CHBA).
CMHC’s main business is mortgage insurance and it does quite well. Its financial statement for 2019, released on May 5, says it declared dividends to the government of $2.02 billion, funded from its retained earnings from prior years and its 2019 net income of $1.58 billion.
CMHC has competition — Genworth Canada and Canada Guaranty, private insurers, are also in the mortgage insurance business and both have said they are not changing their underwriting practices to match CMHC.
It’s a very significant move, says James Laird, co-founder of Ratehub.ca and president of CanWise Financial mortgage brokerage.
“It means that CMHC’s changes have no effect,” says Laird.
And that could seriously affect CMHC’s 2020 financial statement and lighten the government’s coffers.
“It is very unusual that the two private insurers did not follow this move by CMHC. It indicates that they do not agree with the changes CMHC has made,” says Laird. “If the current environment holds, where CMHC has significantly tighter underwriting guidelines, then CMHC’s market share will shrink dramatically and the two private insurers will provide the majority of the default insurance in Canada.”
Other than the change in CMHC’s underwriting practices, the three insurers are much the same.
“Most Canadians source their downpayment from their own savings and investments, along with gifts from family, and those sources remain unchanged. The change to downpayment will not be as impactful as the reduction of the maximum GDS/TDS from 39/44 to 35/42 and credit score,” says Laird. “Once these changes take effect, affordability for most Canadians will be determined by the 35 percent GDS (gross debt service ratio) limit, which uses the stress test rate.”
“The minimum score before was mandated at 600, but banks have wanted 650 for a year or so already anyway,” he says. “It also didn’t mean that the other factors on the credit report weren’t taken into account, too. The banks don’t look just at the score, they read the story in the report.
“It doesn’t mean that lenders and insurers didn’t already scale back on a deal if they felt that a particular application had other risk factors such as low liquid assets, short time on job, etcetera. Prudent underwriting should always be the focus.”
- Getty Images / SunMedia
CMHC’s new minimum Beacon requirement: Who’s going to suffer?
As with most announcements from the Canadian Mortgage and Housing Corporation, the rollout of the organization’s new underwriting guidelines on June 4 has kicked off a storm of criticism, confusion and anxiety. Of the three changes to be implemented on July 1 (what a great Canada Day this one’s going to be), the most controversial is arguably the increase CMHC is making to the minimum credit score required for insured mortgages.
The increase in Beacon score from 600 to 680 has largely been met with consternation.
“The credit score is an imperfect measure,” says Dominion Lending Centres’ Dr. Sherry Cooper. “I know from personal experience that it has nothing to do with your income or wealth. If you have a lot of credit available to you on your cards, even if you don’t use it, it lowers your score.”
Jimmy Hansra of Centum FairTrust Financial Group is another industry veteran who thinks the new guideline, which fails to take into consideration the vast array of individual economic circumstances faced by Canadians, is flawed.
“It isn’t fair,” Hansra says of the CMHC’s reliance on one-size-fits-all policies. “And it doesn’t work.”
Matt Fabian, TransUnion’s director of financial services research and consulting, has a more forgiving view of the changes.
“I don’t think it’s a significant or controversial shift,” he says, “because if you look at the total population of mortgages that we track, only about eight percent are under 680. And a bunch of them, at the time they were originated, might have been above 680 and just dropped down.”
Fabian says a “very small proportion” of mortgages being originated to day involve borrowers with a sub-680 Beacon score, and the ones that make it over the line usually involve manual overrides, high down payments or other fiscal gymnastics on the part of brokers.
But, like most people interviewed about CMHC’s new guidelines, Fabian found their timing surprising.
“How does this help if there’s a significant downward trend in the origination market as a result of the crisis and lockdown anyway?” he wonders. “It’s also interesting that the other two large issuers [Canada Guaranty and Genworth] have decided not to adopt those rules.”
680 – The new magic number
Even though the new minimum credit score has been raised more than 13 percent, Fabian doesn’t see it impacting that many potential buyers.
“It’s a significant shift, but I don’t think it represents a massive chunk of the mortgage population,” he says, estimating that “five to 10 percent of total mortgage applicants” will be shut out of the market by the new standard.
“It’s going to disqualify a certain segment, but depending on an individual lender’s risk appetite, they may not want them in their portfolio from a mortgage perspective anyway,” he says.
It’s not only sloppy credit users who will be squeezed further to the margins. Canadians with short credit histories will be hit hard. That includes two vital populations of potential buyers – millennials and newly landed immigrants; the former makes up one of the largest population demographics in Canada, the latter is responsible for the country’s population growth, diversity and much of its economic might. Both groups will be at an acute disadvantage when they approach the market after July 1.
“Everybody has a story,” Hansra says, referring to CMHC’s assumption that a high Beacon score is the key factor in determining an individual’s credit worthiness. That’s simply not true for immigrants. Someone new to the country and attempting to establish herself – new credit cards, new apartment, new car – is inevitably going to be subject to a high number of credit inquiries.
“Your credit score’s going to go down because you have all of these credit inquiries, not necessarily because you have bad credit,” he says. “All of a sudden, your score can drop from 800 to 660. You’re not seeking credit, you’re just trying to establish yourself in a new country.” A policy change that impacts Canada’s immigrant community at a time when the world is debating the evils of institutional racism is a case study in bad optics.
“A lot of the big lenders have new-to-Canada programs,” Fabian says. “Some of the rules and products are adjusted to reflect that, so there are opportunities and options for this population.” TransUnion research suggests that new Canadians tend to perform as well or better than established Canadians. Many were experienced, responsible credit users abroad, but their credit score, if that’s all one sees, doesn’t tell that side of their story.
Fortunately, Fabian says consumers with Beacon scores of below 680 can bring them up relatively easily by making their payments and monitoring their credit for any forgotten, lingering debt that may be bogging them down.
“It’s not a huge leap for consumers to migrate forward,” he says. “In a given quarter, we see anywhere from 15 to 20 percent of consumers move up in risk tiers.”