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10 Canadian Housing and Economic Trends to Watch in 2013: Part 2

JANUARY 02, 2013

Housing and econo-geeks who find this stuff interesting may want to join me in Toronto in February for a free seminar on housing, the economy, and what it all means for your investment portfolio.  Details here.

Part 1 of this series can be read here.

Yesterday we looked at five trends worth watching in 2013.  Today, five more.

 

6)  Is the weak population growth seen in Q3 the start of a trend?

The latest population estimates reveal two worrying trends in the two provinces most at risk from a housing correction.  Population growth has slowed dramatically in BC and Ontario at a time when resales have fallen significantly, existing MLS inventory is high, and projected new completion for 2013 are set to be among the highest on record:

BC population growth slowed to levels not seen since 2005 while Ontario growth rivaled decade lows seen in 2007.  Strong population growth in BC, and to a lesser extent Ontario, coming out of the recession helped absorb the excess inventory and helped stabilize prices and sales (cratering interest rates and massive mortgage liquidity programs also didn’t hurt).  With the number of units under construction and the high level of expected completions, there’s no way to spin this positively.  This is one trend definitely worth following.

Shown below in green are the units under construction in Vancouver, BC and Toronto, Ontario

On the other side of the spectrum, Alberta saw a major jump in population growth, in no small part from interprovincial migration that sapped growth in Ontario and BC.  And unlike the major metros in these provinces, Alberta’s metros are seeing strong resale activity, low MLS inventory, and projected completions that will fall well below demographic demand at this current pace:

 

7)  How far will housing starts fall?

Completions in 2013 are set to be very high in most large Canadian metros. 

This will be occurring at a time when resales are low, existing MLS inventory is high, and population growth is slowing.  It’s exceptionally difficult to envision developers maintaining their high pace of construction in this environment.

Indeed, we’ve already seen housing starts begin to slow in most Canadian metros (the Toronto condo market being one notable exception).  With housing starts having greatly exceeded demographic demand over the past decade (210K starts annually vs demographic demand in the 180K-190K range), it’s possible, if not likely, that housing starts will fall well below demographic demand for a period of time.

This will be one very important trend to watch.  Residential investment was one of the weakest components of Q3 GDP, which came in at a pitiful 0.6% annualized.  We are at cyclical highs in terms of GDP output and employment generated by residential construction. 

To be pessimistic for a moment, if housing starts were to fall to 150K for a year, it would represent a 2% GDP drag and could potentially result in the loss of more than 250,000 jobs directly from the construction sector.  Note that this does not consider multiplier effects in other industries.

 

8)  How much will credit growth slow?

One branch of economics holds that the business cycle is better thought of as the credit cycle.  If that’s indeed the case, it’s worth noting the significant deceleration in credit growth in Canada.

Credit growth must, by necessity, slow.  This is a good thing in the long term.  Households cannot borrow in excess of their incomes indefinitely.  Of course the implications of going from high credit growth to lower credit growth is that aggregate demand must fall.  Where high credit growth is a “benefit” to the economy in the short term, falling credit growth has the opposite effect.

So with this in mind, it’s worth watching this trend closely.  I suspect that 2013 will be the year that our sky-high debt-to-income ratio begins to level out and perhaps even declines.

As an aside, I’ve received a number of questions about how the $50B increase in the private sector mortgage insurance cap will affect credit growth and house prices.

To recap, private sector mortgage insurers such as Genworth Canada and Canada Guarantee operate with an 90% government guarantee in the event of insolvency.  So if Genworth Canada were to be rendered insolvent, the government would honour their insurance obligations to the banks for 90 cents on the dollar.  Because there is a taxpayer guarantee in place, the government sets limits on their insurance in force, just as they do with CMHC.  That insurance in force cap has just been raised from $250B to $300B.

First of all, it’s important to note that Genworth was already above the $250B threshold.  Their last annual report indicated that they had insurance in force of nearly $270B.  That’s not including the other, much smaller private insurer, Canada Guarantee.  So raising the “ceiling” to $300B is not actually a $50B jump.

But even if it were, let’s consider some facts:

i)  CMHC holds insurance in force of $587B, up from $200B in 2000.  The growth in their insurance book is charted below, as well as their anticipate future growth, as per their 2012-2016 Corporate Plan.  Note that from 2007 to 2010, insurance in force grew by over $40B annually, a flow of insurance that simply cannot be replaced by a one-time $50B increase in the private insurance cap which will be run down over the course of several years.

ii)  More importantly, we must remember that private-sector insurers answer directly to shareholders.  Consider that the big banks are increasingly lowering their LTV limits in markets where liquidity is drying up and prices are falling.  Two examples are Vancouver and the Toronto condo market where brokers confirm that banks are now increasingly uneasy originating uninsured mortgages at +65% LTV, down from 80% mere months ago.  If the banks are seeing price and liquidity risks in these markets, it seems unlikely that private insurers aren’t also having concerns and taking some measures to protect their book.  So the bottom line is that private mortgage insurers can pick up market share, but that’s assuming that they will willingly choose to do so should current trends continue.

All that said, it seems unlikely that this new private sector mortgage ceiling will entirely reverse the current trend.

 

9)  Will arrears rates stay near record lows?

Mortgage arrears rates in Canada are exceptionally low.

Will this trend continue in 2013?  Low interest rates and a reasonably strong economy and labor market would argue so.  The US also continues to grow at a modest pace, Europe has so far remained intact with bond yields signaling increasing investor confidence, while the latest data out of China suggests their economy may also be picking up.

But there are offsetting factors worth considering:

1)  The economy and labor market appear to be slowing and will likely remain weak through 2013.  Should the slowing GDP trend in the past two quarters persist, it will almost certainly weigh on the labor market.  Declining construction activity and continued weakness in real estate industries are also risk factors. 

Of course, these trends could also reverse and provide a nice boost.  But on the basis of probabilities, these will likely be net drags on economic growth, and potentially big ones.

 

2)   Recent trends to restrain credit growth will make it more difficult for some people to continue making mortgage payments.  This will be a particularly serious issue for the “serial refinancers” who have made it a habit of racking up high interest consumer debt before consolidating into lower interest mortgage debt via a refinancing or into interest-only home equity line of credit debt.

I noted in an earlier post that arrears rates are best thought of as lagging indicators of house prices.  Consider:

The widespread availability and use of HELOCs (and refis) very likely masks the true delinquency rate.  Here’s the reality: Very few people will default on debt if they have the means to make payment.  Strategic defaults aside, this is overwhelmingly the case. 

The ‘means’ to make payment include both income and access to additional debt.  Unlike Texas, in Canada it is entirely possible to use a home equity line of credit to make the payment on another form of debt like a credit card or even a mortgage.  If you doubt this, try it for yourself.  Withdraw money from a line of credit.  Use some of the money to pay off another form of debt like a credit card or even your mortgage.  Use the remaining money to make the minimum payment on the line of credit itself.  Is the bank satisfied?  You bet.

At the time I took some flak for making that statement.  But earlier this year, the country’s leading financial regulator moved to rein in HELOC and refis, noting that,

“[…] it can be easier for borrowers to conceal potential financial distress by drawing on their lines of credit to make timely mortgage payments and, consequently, present a challenge for lenders to adequately assess credit risk exposure.”

We’ll soon find out how many Canadians were doing exactly this now that credit rules have been tightened in this area.

Of note, the first email I opened this morning was from the Office of the Superintendent of Bankruptcy Canada with the latest insolvency data.

The key takeaways:

Total insolvencies in Canada rose 18% month/month in October and 7% over last October.

Insolvencies rose 17.5% y/y in Quebec in October, 10.4% in BC. Only small change in Ontario (+2.7%) and Alberta (+0.6%)

Perhaps this is just noise, but it’s one trend I’ll be watching closely.

 

10)  Will Canadian GDP miss the consensus 2% real growth?

I suspect final 2013 GDP will fall below current consensus, but time will tell.  It seems very likely that residential investment and household consumption will be net drags, as will government spending.  Beyond that, it will be a mixed bag. 

All told, it looks like 2013 will be a very interesting and pivotal year in the Canadian housing story.

 

All the best,

Ben

NOTE: All images are property of TheEconomicAnalyst.com and may not be used without written consent.

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Ben Rabidoux
By Ben Rabidoux

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16 Comments

  • Saj said:
    • 1 year, 3 months

    Great post as usual, Ben!

    I'm not sure I understand why lower credit growth leads to a fall in aggregate demand, though. Wouldn't low (but still positive) credit growth still contribute to higher demand, albeit slower-growing demand?

    Interesting discussion on the Canada Guarantee. If Genworth was willing to insure $270M with a guarantee of just $250M, doesn't that suggest they may be willing to ensure $320M+ with a guarantee of $300M?

    I hope you are right, but I don't share your confidence in private sector players on the basis that they report to shareholders. History is full of public companies going down (including several in the US housing bubble) because of a focus on short-term results at the expense of long-term risk.

    At the same time, I'm worried that this is not a "one-time $50B increase...which will be run down over the course of several years". It may signal a willingness on the part of the government to actively slowdown or prevent the major resource allocation adjustment that is needed, as the government may fear that the weak economic growth that would follow the bubble's popping could make those in charge un-electable.

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  • Mandelbrott said:
    • 1 year, 3 months

    Aggregate demand can be equated to income plus the change in debt (what you call "credit growth" can be +ve or -ve) so you are correct in saying that lower credit growth wouldn't necessarily lead to a fall in demand. However, asset prices are a function of the change in debt and therefore the change in asset prices are a function of the rate of change of credit growth. In other words, all you need is decelerating credit growth (not negative credit growth) to start dragging asset prices down. Strong empirical case for this, see Steve Keen's work.

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  • jesse said:
    • 1 year, 3 months

    Good post. Definitely some food for thought on the credit growth front. Credit can slow in a few ways, through less dollar volume of residential loans being issued, paydown of existing loans, and default.

    Slightly related funny quote from the '80s TV show Yes Prime Minister, "When you have all that Arab money earning 12.5% you look a bit silly if you don't lend it out at 14."

    On the 90% guarantee, if a mortgage insurer cannot continue operations, the government will transfer the entire book, or perhaps some of the book, to other insurers including CMHC, or to its own books. If all an insurer's entire book is transferred, its entire book is derated by 10%. That means all policies in force, whether at significant risk of defaulting or not, will then be recast showing a 10% shortfall. Banks provision for this with capital but, if counterparty default occurs (and this isn't necessarily a likely scenario), they have to fully account for the default. If it ends up on CMHC's or the government's books it will, after the 10% haircut, be 100% underwritten, meaning that policyholders won't need to provision additional capital. That's a small reason why CMHC's 100% guarantee is there.

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  • Potato said:
    • 1 year, 3 months

    Arrears and mortgage defaults are definitely lagging indicators: for the mortgage, as long as house prices are rising fast enough the debtor always has the option to sell the house prior to a default if they can't get a HELOC, and of course, they can almost all get HELOCs (at least until recently).

    I was a little worried that just as it looks like the wheels might be falling off this housing thing, the government decided to give Genworth its deposit back...

    Aside: the expression is "all told."

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  • deanincalgary said:
    • 1 year, 3 months

    great post, as usual Ben.

    Another point to consider - we (Canada) are a very small commodity exporter in the huge global economy. If Europe continues to slow, which means China slows, then there will be less commodity consumption. OTOH, our southern neighbours seem to be coming out of their recession. But (my personal belief) the US will slide into a recession in 2013 because of poor job growth and minimal personal disposable income growth, and since the US GDP is driven 70% by consumer spending.......

    OTOH v2 - slowing global growth and increasing US shale oil production -COULD- mean lower oil prices - not good for us in Alberta, but great for the global economy!

    'May you live in interesting times'.......

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  • Kevin said:
    • 1 year, 3 months

    Hi,
    Thanks for your post.
    Could you show income growth, occupancy rates, rental growth, take up rates of new launches.

    How much do these properties yield vs financing cost?

    I read somewhere else that foreign buying (assuming mainly cash) is only a small portion of transactions. How about transactions? Basically I want to know how people are financing their new purchases (first time buyers or roll over from asset sales).

    No doubt prices are ridiculous considering the relative quality of properties (check out thethirtiesgrind.com for a daily dose of humor), but the asset bubble won't pop until some shock to the system or people stop buying. Most of the listings that posed little value haven't sold. Maybe there are still discerning buyers, which goes back to the same problem, what is the financing like?
    Thank you.

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  • Appraiser said:
    • 1 year, 3 months

    Another year and yet another significant increase in prices for the T.O. real estate market.

    P.S. You changed your photo because of me; that makes you my bitch.

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  • Ben Rabidoux said:
    • 1 year, 3 months

    No need to get personal, Ray. Must be a slow day at C.R.E.S if you have this much time to troll. They're not working you hard enough.

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  • Trader said:
    • 1 year, 3 months

    Well, Well, Well, we can now put a face on the sound of stupid

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  • Fact Checker said:
    • 1 year, 3 months

    Nice catch by one sharp-eyed commenter named Yeah Yeah Yeah over at the Globe re: George Athanassakos latest musings:

    George Athanassakos, professor and author:

    Jan. 03, 2013 "The market is due for a severe correction."

    Feb. 23, 2012 "More than ever before, I believe that Canada's housing market is due for a severe correction."

    Apr. 10, 2011 "I believe that Canada's high house prices in relation to incomes, combined with record household debt levels and overinvestment in residential construction, will cause a severe correction in the real estate market."

    Any day now, George. Any day.

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  • don said:
    • 1 year, 3 months

    People have been using the broken clock anology for us housing bears but i do not think this is an apt comparison. I like to think that guessing how many shots would put your drunk friend under the table is better. The inputs booze/credit are the same as will be the result. Being early is not nearly the same as being wrong.

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  • Larry Les said:
    • 1 year, 3 months

    Being early can definitely be the same as being wrong. Price of credit is still low, and staying low. Availability of credit still high, and staying high with (another surprise) increased limits for private insurers. Now, again surprisingly, job growth still strong, and continuing strong...perhaps the real story for the short term (2013) is going to be continuing, rising demand for Canadian commodities as China and the US rev back up...ponder that scenario...then you have at best pockets of weakness in an otherwise relatively robust picture for 2013. Not saying I would put all my marbles on it, but I would consider the possibility and allow for it.

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  • Fact Checker said:
    • 1 year, 3 months

    Speaking of being wrong and /or early. According to Nassim Nicholas Taleb, Professor of Risk Engineering at New York University:

    "Since 2000, in the United States, the stock market has lost – depending on how one measures it – up to $2 trillion for investors (compared to returns had they left their funds in cash or treasury bills)...while shareholders have lost, managers have earned more than a half-trillion dollars for themselves."

    "...there is a problem with academic economists, quantitative modelers, and policy wonks. The reason why economic models do not fit reality is that economists have no disincentive, and are never penalized for their errors...predictions in socioeconomic domains do not work, but predictors are rarely harmed by their forecasts."

    http://www.project-syndicate.org/commentary/improving-managers--incentiv...

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  • Ralph Cramdown said:
    • 1 year, 3 months

    How does one measure it? A cursory glance at the long term charts for both VTI and SPY suggests that Taleb's method of measurement (assuming that the investor took the dividends mailed to him every month and burned them to heat water for his tea) is faulty.

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  • alainjoseph said:
    • 1 year, 3 months

    .it was a great attempt to convey some details about the future of housing trends going to prevail in 2013. It was a bumpy year for the Canadian economy, as concern over European debt and the U.S. “fiscal cliff” cast a shadow over growth. Canada’s economy hit a soft patch in the second half of the year, and see-sawing trends in job creation weren’t enough to budge the unemployment rate much. So let's see what will 2013 bring to the economy/? http://www.safebridgefinancial.com

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  • John said:
    • 1 year, 3 months

    Small clarification:

    The 90% guarantee on GE/AIG doesn't mean CMHC will pay 90% of claims. It means that they will only cover losses over 10% of the mortgage balance.

    I.e. If a mortgage is 100k and it goes to foreclosure and the due to legal costs etc the total claim to the insurer is 20k then CMHC will subtract 100k*10% and pay the difference. In this case only 10k or 50% of the claim will be paid.

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