I’m planning a trip to Colombia. Alone. I’ll be vulnerable to theft, scams, being lost etc. This doesn’t mean I live in fear, never to leave my room. I’m planning on being aware of my vulnerabilities and limiting my exposure to situations where they can be exploited.
The Bank of Canada is doing the same with our financial system. We have economic and financial vulnerabilities in our country. We’re financially exposed if negative macro-financial events happen, and they do.
Here’s a summary of how are Central Bankers are monitoring and preparing our finances for various financial situations.
Key Vulnerabilities In Canada:
Vulnerability 1: Elevated level of Canadian household indebtedness
Debt-to-disposable-income ratio:
FINALLY, Canada’s debt to disposable income ratio has plateaued (and is even dropping?) at 170% at the end of 2017. I’m sure you’ve seen/heard enough warnings about this number number, and I think rightfully so. The warnings were not enough to stop people from borrowing, so our Government introduced two Mortgage rule changes to “stress test” the qualifying of Canadian’s borrowing money.
Residential borrowing (Mortgages and Home Equity Lines Of Credit (HELOC)) have slowed the first four months of 2018. This comes along side lower Canadian home sales volume.
Auto loans:
Auto loans, which are another large portion of “other debt” on Canadian’s balance sheets, grew by 5.5% in 2017. Auto loan origination growth would be more of a concern IF financing through “B lenders” increased. It has not. Auto loan arrears grew from 0.7% to 0.9%.
Increased Mortgage qualifying standards:
November 2016 was the beginning of “stress testing” Mortgage borrowers with less than 20% down payment. This stress test eliminated half of highly indebted borrowers from qualifying for a home. Highly indebted meaning debt in excess of 450% of income!
The 2016 Mortgage rule changes also saw low ratio borrowers (more than 20% down payment) reduce their amortizations to 25 years. This is also an indicator that borrowers are in better financial health because longer amortizations allow for increased debt at lower monthly payments.
The 2018 Mortgage rule changes reduced Canadian’s maximum home affordability by about $82,000. This has effected the Greater Toronto Area (GTA) and the Greater Vancouver Area (GVA) the most because of lower income to home values.
It seems, at this point, the Government is very happy with the increased quality of Mortgage borrowers. That said, the jury is still out on how much this will impact our National GDP. Even today, some borrowers are taking possession of homes that qualified under the old rules. The Bank of Canada is anticipating a reduction of 0.2% GDP by the end of 2019 as a result of this rule change.
Monitoring migration of Mortgage funding:
Provincially regulated Credit Unions and private Mortgage lenders are not required to adhere to Federal Banking regulations (the new 2018 Mortgage qualifying rules).
Credit Union’s I have access to (ATB, Servus, Chinook) have decided to underwrite their applicants according to the new B-20 Mortgage guidelines. I can’t say what’s happening in the rest of the Country? The latest data is that Mortgage origination is NOT growing in Credit Unions at this point.
Mortgage borrowers sensitivity to higher interest rates:
Mortgage borrowers coming up for renewal, who were not subject to Mortgage stress testing, are exposed to potentially higher interest rates. If household income is at or higher than original Mortgage qualifying, these families should be OK. Increased exposure can happen if renewing at higher Mortgage rates with lower family income OR increased personal debt to financially service, or both (lower income, higher Mortgage rates and higher personal debt).
It’s comforting to know many Canadians are not borrowing at their Maximum. Also, Canadians with a variable rate Mortgage have been stress test qualifying for years, therefore are more able to weather rate increases.
Vulnerability 2: Imbalances in the Canadian housing market.
Captain obvious here …GTA and GVA detached home prices drove the Canadian housing market. As a result of the new Mortgage qualifying rules, more buyers are turning to condos because of affordability pressures. Investors (speculators?) are also joining this new opportunity which is driving condo prices higher and therefore is a increasing market risk.
Seemingly, investors are willing to purchase and rent condos with negative cash flow expecting the offset of equity gains to eventually turn their investment profitable. The risk is a flood of condo listings should the anticipated trajectory of equity gains change.
GTA and GVA condominium construction is at an all time high which might prove difficult to sustain price gains in these markets. The Calgary condo market is all to familiar with supply surpluses putting pressure on values.
Vulnerability 3: Cyber threats and operational interconnections.
The bottom line is cyber attacks will happen. Canadian Government agencies are working with Big Banks here in Canada, and internationally, to plan for a quick recovery. Even a small but publicized attack can drastically effect consumer confidence that could reflect in major market changes.
Conclusion:
The jury is still out on the FULL impact the recent B-20 Mortgage rule changes will have on Canada’s housing market and trickle into changes to Canada’s GDP. I think the policy makers are in favour of early results in less borrowing and debt repayment.
I think Calgary’s housing market is not as exposed to major downside risk as the GTA and GVA markets because our upside, especially in the last three years, has be significantly less (in some cases down). I do think understanding National housing fundamentals is important for context of National Real Estate policy decisions. Clearly, recent Mortgage rule changes were targeting GVA and GTA detached housing markets. Early data is showing, in combination to BC and ON Provincial housing regulation, borrowing is slowing. However, the market is reacting with investment dollars flowing to lower priced condos.
I hope this is helpful for you!
Talk soon,
Chad Moore
