If Canadian residential housing were to plop, would the big banks take a dive along with them?
That’s been a simplistic point of view held by some people who misunderstand the Canadian banking system, the depth of CMHC coverage for high-risk, high-ratio loans, or those just trying to scare the poop out of you so you’ll buy gold. Even smart people, like analyst Ben Rabidoux, have been known to make this error, when he hooked up with a metals-hawking, Van-based financial advisor a few years ago. Since then banks have scored record profits, quarter after quarter, and bullion has lost a third of its value. Oops.
Does that make banks impervious to a real state correction?
Definitely not. Shrinkage in the growth of mortgage portfolios is always a major worry for the bankers – something they’ve been dealing with for some time already (personal and real estate loans are both under pressure). In addition, low interest rates squeeze margins. But the banks have meanwhile been concentrating on diversifying into more international operations, while beefing up the wealth management, insurance and capital markets revenue streams.
In other words, consumers are drowning in debt, there have been virtually no new jobs created in 2014, and yet TD’s marking record money, Scotia profits are ahead 57%, and together the Big Six earned$7.37 billion in the second quarter alone. In other words, $80 million a day – in an economy with stagnant growth, tipped-out consumers and historically low rates. Meanwhile eight in 10 Canadian residential mortgages – and all of the ones with less than 20% equity – are backed not by the banks, but by the taxpayers. If you worry about risk, worry about that.
Of course, if real estate does tank, there will be a kneejerk reaction (thanks to the Chicken Little analysts and advisors), and bank common shares may decline in value. Yes, vultch time. But if you worry about such things, just buy bank preferreds which are immensely more stable, pay dividends approaching 5% and give you quarterly income which is taxed at 50% less than your paycheque. They lose capital value when rates rise, but we all know that will be a gradual event and fixed dividend payments continue unabated.
Here’s another view, from Morningstar equity analyst Dan Werner, FWIW.
Now, here’s something better to fret over. Back when the US housing market was at its frothiest, with the foam spilling over into Canada and HGTV pumping ‘Flip this House’, everybody wanted to be a flipper. Conversely, interest in specking in residential properties crashed in the years following the GFC, with HGTV turning to shows about renos and morphing your dank basement into a subterranean rental suite for poor people. Well, guess what? It’s back. According to Google’s trending-thingy, people have been searching for flipping news and advice in growing numbers. Here’s the chart.
Obviously we’re nowhere near at pre-crisis levels, but the line’s progress looks pretty convincing. Is this another sign of late-market madness?
Don’t you love rhetorical questions?
Last week I picked on Paul Etherington, cartel boss of the nation’s biggest real estate board. It was so much fun, let’s do it again. Easy, too, when he writes drivel like this:
“Making regular mortgage payments represents a method of forced savings: as you pay down the principal on your home loan, and your property’s market value appreciates, your home equity builds, setting you on a path to greater financial structure, even if you count poor budgeting or excessive spending among your vices.
“In addition to compelling you to take a disciplined approach toward your financial future, homeownership offers several other benefits that are equally important. A 2012 study…found that respondents who had recently transitioned to homeownership reported feelings of improved health, pride of ownership and ties to the community.”
See what I mean? Houses always go up, so they’re good investments, and you’ll be okay even if you piss away all your income. Just keep making those loan payments. Hey, and mortgages are healthy, too. So get a big one, kids.
Sadly, our society oozes with people who believe this stuff. And, from time to time, we get a glimpse of the potential mess they’re walking into – not to mention the detritus all their house lust could leave for Canadian taxpayers. Such a glimpse is here, in the latest data from the guys who make 95%-financing possible, CHMC, as flagged by the trade site, Canadian Mortgage Trenda.
The ugly stats tell us this about what the masses are doing lately:
- In the first six months of this year, CMHC insured 143,151 new mortgages worth $25 billion
- Of all those borrowers, 88% borrowed more than 85% of the property’s value.
- The average down payment was just 8%
- In fact, with 70% of all loans, the average down was less than 10%.
- The typical loan equaled 92% of the property’s sale value.
- The average insured mortgage is $231,000.
- CMHC lending plunged by 13.3% in the first six months of this year compared with 2013.
- An estimated 80% of all home sales in Canada now have an insured mortgage – meaning the buyer couldn’t muster 20% down.
The federal agency is not telling us how big the mortgages are for those putting the least amount down, but the picture is scary enough. An average down payment of just 8% – when you consider that includes a fat CMHC premium heaped on top of the equity loan plus (quite likely) a repayable RRSP homebuyer’s snatch – shows just how much floating debt most fools are willing to walk into.
So long as real estate values hold or continue to rise (like Mr. Etherington promises), then we might be able to keep the wheels form falling off. But eventually the market will correct, equity levels will decline, and this giant vat of debt will remain. Now there’s a new poll of analysts and housing economists showing more of them are worried. In fact, they think the chances of a “steep fall” in prices have increased in the past twelve months.
The Reuters survey showed most smart guys (“many of whom work for mortgage lenders,” said the company) think house prices will continue to creep higher. But seven in 20 believe the chances of a market meltdown have intensified, particularly in Toronto and Vancouver. Said Queen’s Prof John Andrew: “The risk has increased due to house price increases significantly exceeding income growth and the oversupply of condos in downtown Toronto.”
The big threats are well-known to readers of this pathetic yet spoonable blog: higher mortgage rates, especially when the BoC starts swelling next year, and the expanding sea of debt (shown by the CMHC stats above) being swallowed by people who obviously can’t afford to buy. But the experts don’t expect a massive price tumble, or a US-style houseaggedon.
Maybe they should. After all, the American real estate market peaked in 2005, but didn’t convulse until ’08. It’s simply a myth that these events take place in months, because house prices are massively sticky. Sellers are greedy little things (especially the FSBOs), who would rather sit on the market for nine months, then cancel the listing, than reduce the price 10%. It can take a year or two for a general price decline to ripple through, but once it does then the dominoes start to fall. Listings increase and buyers decrease. It’s already happening in secondary markets across the land.
This does not mean anybody with a house, lots of equity, and other investments should bail in fear. But the vulnerable – house-rich, pensionless Boomers and cashless, horny Millennials – need a reality check.
As for the 143,151 who just bought at peak house levels with 92% financing at rates destined to increase, well, pucker up.