Credit Picture Improving, Says Tal

Benjamin-TalDebt-to-income may be at 148%, but CIBC economist Benjamin Tal says the mortgage picture isn’t as bleak as some have portrayed it.

Here are snippets of his statements from a BNN interview Tuesday:

  • “We cannot talk about the quantity of debt without talking about the quality of debt.”
  • “The quality of debt in Canada is totally different (than in the US before the crisis).”
  • “Subprime in Canada was less than 5% (of overall mortgage volume). In the U.S. it was 33%.”

  • The number of Canadians vulnerable “in terms of very low equity on their house and very high debt service ratio” is 4%.
  • Canadian credit quality has been “improving” for the past few years.
  • Canadian credit growth is now at a “9-year low.”
  • The “Canadian real estate market is stagnating,” which will lead to slower credit growth (because people won’t borrow as much if their homes stop appreciating).
  • Canadians have become more sensitive to a rise in interest rates.
  • When rates rise, “of course you will see some increase in defaults.” However, rates rise for a reason, Tal says—because the “economy is doing better.” When the economy improves, unemployment falls.
  • “The unemployment rate, not interest rates, is the number one factor impacting defaults.”
  • Higher rates will reduce consumption because people are forced to service more expensive debt.

There’s a silver lining to that last point. Some economists believe that higher rates (and lower consumption) will exert a drag on the Canadian economy and self-regulate interest rates somewhat—i.e. keep rates lower than they otherwise would be if Canadians were not in so much debt.

Rob McLister, CMT

  1. Subprime in Canada was less than 5% (of overall mortgage volume). In the U.S. it was 33%.”
    That depends on how you define subprime. The fact that canadian consumers are exposed to interest rate risk every 5 years is already one element of what caused the subprime house of cards to fall. In the US most people get a 30 or 15 year rate guarantee so they never face that risk.
    The number of Canadians vulnerable “in terms of very low equity on their house and very high debt service ratio” is 4%.
    Average equity in Canada is 63%. Average equity in the US before their crisis was %60. Both looked healthy, and it didn’t make a bit of difference.
    Canadian credit quality has been “improving” for the past few years.
    Everything looks rosy on the back of an asset bubble. No argument there.
    The “Canadian real estate market is stagnating,” which will lead to slower credit growth
    This we can agree on. The question is if that stagnation marks the the start of a decline or not.
    When rates rise, “of course you will see some increase in defaults.” However, rates rise for a reason, Tal says—because the “economy is doing better.”
    He seems to have forgotten where fixed mortgage rates are set.
    “The unemployment rate, not interest rates, is the number one factor impacting defaults.”
    And the number two factor impacting defaults? Negative equity. All it takes is a couple vulnerable individuals to start the slide.
    What is interesting to look at is Seattle’s situation. They thought they were immune for many of the same reasons. Their economy is good, they didn’t have ninja loans, they have a great west coast location that people want to live in, and their credit quality seemed fine. Only problem is, their fundamentals were still out of whack.
    After seeming to defy the downturn for almost two years after it started in the bubblier cities, they are now down 30% and it looks like they’re starting their double dip.
    They weren’t different, and neither are we.

  2. You hit the nail on the head…I couldn’t agree with you more…we always think it won’t happen to us, we’re smarter then them…
    Just work out the numbers on buying an investment property…lets say a condo townhouse in Mississauga, even with 20% down payment($70,000)your rent can’t cover your carrying costs not to mention no return on your 70k. Just watch property value’s fall, it’s only a matter of time…

  3. Have to disagree somewhat with your first point. Most subprime borrowers in the US only qualified for ARMs, with extremely low teaser rates that tripled or quadrupled in a couple years’ time. These products don’t exist in Canada. Yes, Canadian mortgagors face interest rate risk every 5 years, but it is highly unlikely that they will face the same levels of rate increases that the ARMs bestowed on our American counterparts.

  4. hmmm… interesting timing by Mr. Tal… it’s like someone just called an election and asked for a favour from an economist to promote the “economic recovery” and make every feel happy!
    (no – this could never happen!)

  5. LS-
    Several of your statements are fallacious.
    #1 – When you say “most people get a 30 or 15 year rate guarantee so they never face that risk.” That is false. Most US mortgages are fully open. Americans typically refinance within 3-7 years. These people are no more insulated than Canadians from interest rate risk, despite their initial 15-30 year terms. Therefore, by your definition, the US subprime count should be even higher, relative to Canada.
    #2 – You are ignoring part of Ben’s statement. The 4% vulnerability basket is not just based on equity. It is a two-part statistic based also on debt ratio. The great majority of Canadians who hold mortgages have total debt ratios well below the 40% standard.
    #3 – My understanding from listening to Ben at a recent symposium is that credit quality has been improving, in part, because a larger proportion of Canadians getting mortgages have been higher income earners. He defined higher income as $50k+. I’ll reserve further comment on this because there may be more to his point that I am forgetting.
    #4 – Agreed.
    #5 – It doesn’t matter where fixed rates are set. Rates eventually rise together.
    #6 – You wrote: “All it takes is a couple vulnerable individuals to start the slide.” It takes more than “a couple” of individuals, even figuratively speaking. More importantly, equity has gone negative before– when mortgage carrying costs comprised a higher ratio of borrower income. Defaults still remained low. 1989 is a good example.
    The reality is that prices will fall eventually. No question about it. That fact, alone, does not foretell defaults.

  6. Interest rate are going to start going up and not just 1 or 2%…inflation is going through the roof but both the US and Canada report low inflation…TODAY EVEN WAL-MART CEO has raised the concern of inflation…
    Inflation has been here for years—in the form of “downsizing” packaged food. Remember a package of cookies was A PACKAGE OF COOKIES?
    That was way before the downsizing of boxes of cereal. Notice how small a box of cereal is, with the sky-high price?
    Canned goods, too. We used to get a 16 oz. can of cranberry sauce. It was “downsized” to 14 oz. and it cost more.
    Fresh food prices are way up all over the world.
    In the US Entitlement and Social Security payments, which account for a substantial portion of the federal budget, are indexed to CPI. Social Security recipients have not had a cost-of-living increase for two years now. If inflation were higher, Social Security and entitlement payments would be higher and the budget deficit mess would be even worse. I would suggest that the federal government has a strong motivation to low-ball inflation.
    Inflation is going to force interest rates much higher which will bring prices down on Real Estate…
    Canada is not going to be spared.

  7. It’s inevitable that the alt/B segment will increase in market share over the coming years. Several economists, including David Rosenberg and Derek Holt, have went on the record to say that Canadian housing prices are overvalued in many areas.
    Canadians have got used to cheap interest rates for the last 2 1/2 years. Add to the mix the recent events in Japan and the European debt crisis that are now poised to hamper any moves by the BoC on interest rates and what you get is people feeling invincible that low interest rates are here to stay.
    When you feel invincible, you get complacent. Instead of using the opportunity of low interest rates to pay down debt and deleverage, the Canadian consumer has continued to take on even more debt. So what does that tell us?
    First, that wages have remained stagnant while the cost of living has seen remarkable increases. For example, in late December 2008 oil (WTI) was trading at about $31 a barrel. And now, barely two years later, it almost quadrupled in price. The fact that the recent spike is seen by many economists and analysts as short term noise is irrelevant to the consumer who ultimately has to put up with higher energy prices. The cost of driving around has effectively doubled.
    Second, consumers who purchased real estate at the peak of the real estate bubble in 2007-2008 and subsequently in 2010 took on bigger mortgages which ultimately require more income to service. Extremely low interest rates made the mortgage payment seem comfortable without taking into account the market’s volatility. When everyday expenses continue to increase and income stays flat, coupled with the fact that a lot of people already took on more debt than they can comfortably handle in the worst case scenario, the consumer increasingly resorts to using credit to pay for everyday expenses.
    Buoyed by extremely low rates of HELOCs and personal LOCs, consumers spend without thinking about what will happen once rates start to rise or if there’s a correction in the housing market and the value of their home decreases. While some economists have projected a decrease in housing values of as high as 25%, I think a decrease of even 10% would do more than enough damage. While I don’t believe that defaults will skyrocket as a result of such a correction, once this happens the banks will inevitably start to tighten their lending again, just as they have done during the recent financial meltdown, and the end result would be people who are in a position of having too much debt and too little income will have nowhere else to turn but to lenders who specialize with this level of risk.

  8. You state Seattle never had “NINJA” loans,,,give me a break, what did you think Washington Mutual (WAMU) did.

  9. Hi Lior, You’re dead on with this: “banks will inevitably start to tighten their lending again…” I can still vividly remember how hard it was to get high-ratio refis approved with insurers during the last housing dip in 2008.

  10. You do know that just because wamu was involved in the practice, doesn’t mean it was concentrated in Washington, much less Seattle, right?
    Fact is seattle’s economy was and is still good. There would not have been a significant percentage of poor quality loans.

  11. On your point #1. There is a huge difference between being forced to refinance every 5 years and having the option to refinance. Not comparable at all when were talking risk. In a rising rate environment those Americans will be far less likely to refinance that often. With 30 year amorts under 4% they have the safety of staying put.
    #2. I dont have the stats for this to compare with the us situation so I can’t say anything here.
    #3. Perhaps more higher earners are getting mortgages, but the ownership rate is near 70% and the price to income is higher than it was in the us. Can’t all be high income earners.
    #6. Agreed. No one knows how many it will take or whether it will mirror previous cycles.

  12. Nobody ever talks about gas prices. It is costing me $10 to $15 a week extra in gas per vehicle. On a $150,000 mortgage if my rate goes from 2.25% to 3.25% then my payment goes up $76 on a 25 year am.
    The gas price increase on the two vehicles I have in the family is costing me $120 extra per month.
    So then my bag of cookies cost me more and so on.
    What do I do? I stop buying TV’s and furniture and going out for dinner as much.
    Every one follows, economy drops off and the government has to drop rates to try to get things going.
    Glad I stayed with variable. Not really thinking increasing rates controls inflation other than increasing the dollar and making gas and my sandals from China cheaper.

  13. LOL ….did you not notice high ratio refis are basically gone with the reduction to 85%. Why pay a CMHC premium of 1.95% to get 5% more out out your house. Thinking people with that kind of equity are not the concern for lenders. As the market slows banks may loosen up as it is all about market share. Remember lending and banks are not really logical. Also CMHC and GE just took a big hit to their profits with the latest round of cuts. Loosing that extra 15 points for the 35 year am has got to hurt especially when most people with 35 year ams go biweekly and cut them to 30 anyways or only had to take 35 because of the MQR rate.

  14. Sure! At the same time they also raised the rates on VRMs and HELOCs. If you were unlucky enough to lock the spread after the hike, the rate went from prime -.90% to prime +1. If your personal finances are already stretched, these kind of increases, should we see them again in the future, can cause serious problems. After all, HELOC rates can be reset at any time.

  15. Hi Mike,
    Real estate downswings have always shown a pattern of tighter lending, for obvious reasons. A guy who’s leveraged and putting down only 5% has a lower chance of approval, other things being equal, in a falling market than a rising market. That’s just the reality.
    More than ever, there is tremendous scrutiny on default ratios. Defaults impact profitability in many ways, and are just as much a concern as market share, if not more so.
    By the way, 90% refis can still be done at reasonable rates with cash-back mortgages, and the math makes sense in a lot of cases. We had a story planned on this already, and it should run soon.

  16. LS
    It is absurd for you to imply Canadian mortgages are “subprime” because they have rate resets every 5 years. There have been 5 year renewals in Canada for half a century. That is a very illogical comment.

  17. Dave, I’m not saying Canadian mortgages are sub prime. I’m just saying that the common short renewal periods at a time of record low rates presents some of the same risks. A consumer able to afford today’s rates might be in for hardship when they renew at possibly significantly higher rates in a few years.

  18. Let’s not play a game of semantics. You wrote: (Subprime in Canada was less than 5%)…”That depends on how you define subprime.”
    You were clearly trying to insinuate Canadian mortgages are subprime-like, which is completely unfounded.
    “Subprime” is a class of credit quality. Associating term length with credit quality is, as I’ve stated, absurd.

  19. Shorter terms don’t make Canadian mortgages more risky – at least not statistically speaking. Compare MBA data with CBA data. Canadian arrears have been less than US arrears in the last three periods of rising rates. I would have looked back further but the data only goes to 1990.

  20. I understand the tightening of the lender rules, but doesn’t that negatively impact the economy even more? Don’t we want people to buy property to stimulate the economy? I am not saying they should give everyone a mortgage that has a heart beat, but turning people away with decent credit and jobs seems unhealthy. My Calgary Real Estate blog has posts that some of your readers might find interesting as well. Thanks for the post!

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