Brookfield RPS and Moody’s Analytics recently started issuing monthly House Price Forecasts. Their model predicts that Canadian home prices (on average) will rise just under 2% a year for the next decade—about the rate of inflation.
But a long-term uptrend doesn’t preclude a housing correction. That’s why lenders try their best to model the domino effects of a real estate selloff, if and when one does occur.
Among other customers, Brookfield sells its new forecasting product to financial institutions needing to stress-test their loan portfolios. Its modelling tool lets users test “what-if” scenarios on a range of extraordinary housing and economic events.
Some of those events are specified by OSFI. The banking watchdog requires that its regulated lenders stress-test their portfolios to determine how and when their viability may be compromised.
OSFI’s Internal Capital Adequacy Assessment Process (ICAAP), for example, requires that, at a minimum, FIs analyze the following events:
A 200-basis-point interest rate shock
A real estate downturn equivalent to a 30% drop in home values
Brookfield/Moody’s House Price Forecasts facilitate such testing by allowing lenders to “get a detailed view of what a broad-level scenario could mean at the province and metro level,” says Jessica Schaefer, AVP at Moody’s Analytics. “In Canada, at least at the moment, the regulator is less specific in the nature of the scenario…” One could argue that implies even more need for regional stress-testing (e.g., assessing what happens in Alberta when oil plunges to $35 or less).
On a national level, Brookfield/Moody’s publishes a large-scale financial shock scenario. That particular model assumes that mortgage rates spike a little over 200 bps in 12 months. In turn, “Brookfield RPS home prices in [that scenario] fall by about 16%,” Schaefer says.
“Our protracted recession scenario involves a deeper decline in house prices of over 25%.” That model, she adds, is accompanied by an overall decline in interest rates, “making it very similar to the 2008-2012 experience in the U.S.”
It makes you wonder how an extended recession would impact home prices if Canada’s policy rate was already near zero. In such an occurrence, rates could not fall any further to reinvigorate the economy (potentially a big problem). That type of what-if is exactly the reason why lenders use this sort of tool.
Sidebar: Brookfield/Moody’s forecasts are based on regional supply-and-demand factors, and macro influences like interest rates and unemployment. Brookfield says the methodology “assumes short-term serial correlation in house price growth with long-run mean reversion to a level consistent with economic fundamentals.” (More details on its methodology)