Canada’s Strained Housing Markets

1. Canada’s Strained Housing Markets March 7, 2013 Derek Holt Vice-President, Scotiabank Economics

2. Outline • 1. Macro backdrop & the Bank of Canada • 2. Canadian Housing: • Strains • Mitigating Factors • Why It’s (Somewhat) Different From the United States • Pockets Of Concern

3. The Macro Backdrop – BoC On Hold Throughout 2013-14

4. 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

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

6. Among The World’s Best Corporate Balance Sheets Source: Statistics Canada, Quarterly Survey of Financial Statements, Scotia Economics

7. Canadian Housinga. The Strains

8. Canada Is At A Cycle Top In Housing Source: K:\DATA\CANADA\Housing\Home Ownership.xls 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.

9. Canada Is At An Exhausted Point In The Consumer Cycle Real consumer spending indexed to 2007Q1 = 100 Canada US Euro zone Japan U.K. Source: OECD, Eurostat, UK National Statistics, Scotiabank Economics.

10. Canadian Renovation Spending At A Record High Canadian Renovation Spending C$ bns, nsa, 4-quarter moving average % of personal disposable income, nsa, 4-quarter moving average Source: MLS, Statistics Canada, Scotiabank Economics.

11. Sharply Cooling Canadian Housing Resale Markets

12. Canadian House Prices In Early Decline Phase

13. Home Price Indices – Repeat Sales Metric index:Jan 2000=100 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.

14. Canadians Have Higher Debt… But Stronger Balance Sheets Canadians’ Debt-To-Income Now Higher… … But Less Debt Used To Buy Assets household credit liabilities as % of disposable income household debt as % of assets US US Canada* Canada* * Includes households, non-profits and unincorporated business.Source: U.S. Federal Reserve, Statistics Canada, Scotiabank Economics.

15. Canada’s Debt Service Burden Is At An All-Time High Distorted by accounting change Source: Bank of Canada, Statistics Canada, Scotia Economics.

16. 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

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

18. Scenarios For Housing Starts

19. Weakest Household Debt Growth Since The 1990s… Common/raffi/derek/Household Credit Cannibalization - Back to 90's.xls

20. …Especially For Consumer Loans Common/raffi/derek/Household Credit Cannibalization - Back to 90's.xls

21. Canadian Housingb. Mitigating Factors

22. 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

23. …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.

24. Assessing Mortgage Rule Tightening

25. Good Reasons For Rising High-Rise Housing Demand? Housing Starts % share of total • Better affordability • Favourable demographics • Lifestyle choices • More selection • Urban renewal / intensification • Tight rental vacancy rates • Investor purchases Single-detached Apartment Source: CMHC, Scotia Economics.

26. Canadians Have More Home Equity & More Real Estate in their Portfolio … and More Real Estate Assets Canadians Have More Home Equity… Real estate as % of total household assets Real estate equity as % of real estate assets Canada Canada US US Includes households, non-profits and unincorporated business.Source: U.S. Federal Reserve, Statistics Canada, Scotiabank Economics.

27. Canadian Housing -c. Why It’s (Somewhat) Different From The U.S.

28. What Makes Canada’s Mortgage Market Different? • 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)

29. Canadians Usually Don’t Default When House Prices Correct trough to peak in provincial mortgages in arrears, bps 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.

30. 2. Canadian Housing –d. Pockets Of Greater Concern

31. Canadian Households More Heavily Leveraged Than Most

32. Toronto Condo Investors Under Water

33. Toronto’s Luxury Condos Adding To The Overhang Opening Date: January 2012 April 2011 Summer 2012 August 2012 • 25 storeys • 101 residences Residences at the Ritz-Carlton Trump International Hotel & Tower Shangri-La Toronto Four Seasons Private Residences (East & West Towers) • 55 storeys • 253 hotel rooms • 103 residences • 53 storeys • 267 hotel suites • 159 condo units • 65 storeys • 118 residential units • 261 hotel rooms • 66 storeys • 202 hotel rooms • 287 residential units Source: Andrew Barr/National Post, THERESIDENCESTORONTO.COM, TRUMPTORONTO.CA, SHANGRI-LATORONTO.COM, YORKVILLERESIDENCES.COM.

34. 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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