Mortgage and consumer debt default

House prices across Canada fell nearly 10 per cent and sales slipped 42 per cent in November compared with the same month last year, a drop the Canadian Real Estate Association says it hasn't seen since the last housing recession nearly two decades ago.

"What struck me, with the exception of a couple of markets, is that there has been a very sharp decline in sales activity over the last couple of months," said Gregory Klump, chief economist at the Ottawa-based association also known as CREA.

CREA said 27,743 homes were sold last month across Canada, a drop of 12.3 per cent compared to October and "the lowest level for monthly activity since January 2001." That follows a 14-per-cent sales drop in October, compared to the previous month.

Klump said he hasn't seen this type of month-to-month dropoff since 1989, "as we entered the last housing recession."

Housing and commercial real estate prices plunged in the late 1980s after a runup of several years when the economy was booming. The housing decline led to a price drop of up to 20 per cent in many markets and was triggered by rising mortgage rates and the lingering impact of the 1987 stock market crash

Klump cites the current recession and tighter credit markets as reasons for the latest sales slump.

"What we are seeing is a broad trend across Canada of very cautious buyers, and very cautious lenders," Klump said.

Part of the problem, Klump said, is that few people are able to secure mortgages.

Klump said he is hearing a "growing body of anecdotal evidence" that buyers who received pre-approved mortgages are no longer approved when it comes time to close the sale of their home.

"The last time I heard about such things happening ... would have been at the last housing recession," he said.

The biggest year-over-year sales decline was in British Columbia, where sales fell 62 per cent year over year.

"It is one of the markets that had a big run up in price. They are also one of the first provinces where buyers became cautious in recent months," he said.

Klump estimates the drop in sales translates into at least $2.8 billion less in spinoff consumer spending, which includes everything from new furniture and appliances to renovations.

November home sales totalled $7.9 billion, down 11.7 per cent from the previous month and the lowest level since January 2004, CREA said.

Jim Murphy, president and CEO of the Canadian Association of Accredited Mortgage Professionals, said there's no question lenders are being more thorough in reviewing their borrowing customers in the current economic environment.

"However, if you have steady employment, a good income and a healthy credit score you shouldn't have any difficulty in securing a mortgage," Murphy said.

Scotiabank economist Adrienne Warren agrees there is more scrutiny from lenders today. She also pointed to Ottawa cancellation of the 40-year mortgage product in October, which has resulted in some "buyers at the margin being unable to get credit."

Warren said the sales drop is due to many home buyers putting off the purchase in the current recessionary environment, where layoffs are being announced across all industries.

"It's understandable buyers are nervous," Warren said.

"Stock market declines are also pushing people to the sidelines for the time being."

TD Bank economist Millan Mulraine said in a note to clients that the new housing report "underscores that the Canadian housing correction continued in earnest in November ... . However, the deceleration in the pace of home price depreciation does offer a silver-lining in this report - albeit marginal."

The Bank of Canada warned last week that mortgage and consumer debt defaults could rise "significantly" if the global financial crisis deteriorates. It said the number of "vulnerable households" - the three per cent with a debt-to-income ratio above 40 per cent - could double by the end of next year under this pessimistic scenario.

The central bank notes that this would be a worst-case scenario. It said the "most likely outcome" is for global markets and credit conditions in Canada to gradually improve.

Merrill Lynch Canada economist David Wolf said while the percentage of mortgage delinquencies in Canada is low, at 0.29 per cent of about 3.9 million mortgages as of September, it's a 17 per cent year-over-year increase.

Wolf said that is the biggest rise since 1996, and that delinquencies in Alberta, where house prices started falling first, were up 130 per cent.

He said the delinquency rate should in fact be lower, noting that in January 1990, "right around the peak in house prices and just after the cyclical trough in unemployment" mortgage arrears in Canada were at 0.18 per cent. He notes they nearly quadrupled over the following two years.

"The current relatively low level of delinquencies has masked a disturbingly large recent uptrend again, even before things really fell apart this autumn," Wolf said in a note to clients late last week.

He also cited a Bank of Canada study released a year ago that said mortgage default rates would rise to 2.25 per cent under a "very extreme" scenario of a 23 per cent aggregate drop in house prices.

"In sum, the relatively low level of mortgage arrears in Canada is of no comfort to us. Delinquencies are a lagging indicator. Relying on them as a forecasting tool is like driving while looking in the rear-view mirror. It's a good way to crash," wrote Wolf, who in recent reports has has turned bearish on the Canadian housing market.

A few months ago, he predicted Canada's housing market is following the same troubled path that eventually led the United States market into a major downturn, but with a two-year lag.

He noted that U.S. resale home prices accelerated through 2005, peaked in early 2006 and have declined ever since. Meanwhile, Canadian resale home prices accelerated through 2007, peaked in early 2008 and have been falling.

He has also challenged the prevailing view that Canada's housing and mortgage markets are more stable than their U.S. counterparts, warning that households in this country are so indebted that it's only a matter of time before we see a major downturn here as well. .

Bank of Canada warns of possible debt, mortgage defaults

A significant number of Canadians are at risk of defaulting on mortgages and other loans if the global financial crisis deteriorates and triggers a deeper recession, the Bank of Canada warns.

In a sobering assessment of the financial crisis, the central bank concludes that significant risks remain for both the global economy and Canada if credit conditions don't begin to improve.

"With household balance sheets under pressure from weak equity markets, softening house prices, slowing income growth, and record-high debt-to-income ratios, a severe economic downturn could result in a substantial increase in default rates on household debt," the bank writes in its December financial systems review released Thursday.

The Bank of Canada says the number of "vulnerable households" - the three per cent with a debt-to-income ratio above 40 per cent - could double by the end of next year under this pessimistic scenario. That would mean tens of thousands of households could face crushing debt as Canadians lose jobs and family incomes drop to the point where they can't pay their bills.

The central bank notes that this would be a worst-case scenario. The "most likely outcome" is for global markets and credit conditions in Canada to gradually improve, it states.

This is partly because central banks and governments around the world have leaped into action with extraordinary measures such as cash injections, asset swaps and credit guarantees to backstop financial institutions to pump addditional billions of dollars of credit into the economy.

But the Canadian central bank's top officials also warn that the crisis is far from over and that there is "a significant risk of mutually reinforcing weakness in the financial sector and in the real economy."

That's the kind of negative feedback that felled the American economy, noted Douglas Porter, deputy chief economist with BMO Capital Markets, the brokerage arm of Bank of Montreal, adding it is no longer far-fetched to think it could happen here.

"Given the fact we're looking at the recession in the teeth, some of the worst-case scenarios have to be studied a little more closely," he said.

"It looks like we're going to get as close to the bank's worst-case scenario than anyone would have imagined possible as recently as three months ago."

After resisting the call for months, the Bank of Canada declared the economy in recession Wednesday when it slashed its trendsetting interest rate to the lowest level in 50 years at 1.5 per cent.

Most economists are forecasting growth at or below zero for 2009 with job losses of more than 100,000 and an unemployment rate above seven per cent.

For much of the last year, experts said the Canadian economy would perform better than the recession-ravaged U.S., where the housing, financial and manuufacturing sectors have been battered and the services sector is now feeling the effects.

But now, the slump in the auto, manufacturing and forestry industries in Ontario and Quebec has spread to the resources-based West as oil projects get shelved because of low crude prices and mines close because of slumping prices for nickel, copper, zinc and other primary metals.

Pressure is mounting on the federal government to shock the economy into recovery with a big stiumulus spending plan in its Jan. 27 budget. Late Thursday, Bank of Montreal's Porter urged Ottawa to spend as much as $16 billion next year to arrest the economy's slide into recession.

Porter said such a package should include spending on roads and bridges as well as a one-time bonus for seniors on public pensions, temporary cuts to payroll taxes and the GST, and spending vouchers that would give Canadians government cheques on the condition they spend rather than save.

As well, Porter says Ottawa should consider a one-time financial transfer to the provinces, which could put the money more directly to use.

Given the rising uncertainty, the Bank of Canada officials outlined five potential risks for the world and Canada, including a deeper and more prolonged recession as banks compelled to restore cash reserves tighten the screws on credit conditions even further.

For Canadians, the repercussions will be profound - higher joblessness, lower income growth and more home defaults from crushing debt loads, the bank says in its worst-case assessment.

And while Canadians' access to credit has not tightened significantly during the financial crunch, this could change if the crisis persists, the bank says.

The risk assessment is noteworthy for its predominantly gloomy outlook - although it remains a hypothetical one - and for the fact it was written by the bank's governing council headed by governor Mark Carney, rather than by lower-rank bank staff as is usually the case.

In the United States, millions of Americans have lost their homes in the last two years with the collapse of the sub-prime, or high-risk mortgage market, which led to sharply higher interest rates for homeowners with poor credit and produced widespread foreclosures.

In Canada, however, the housing sector has been more stable, but the jump in home prices that led to soaring values in Vancouver, Calgary, Toronto and other cities has begun to reverse. Statistics Canada reported Thursday that new home sales fell for the first time in a decade in October, dropping 0.4 per cent from September.

According to the latest figures compiled by the Canadian Bankers Association, the percentage of mortgages that have gone unpaid for at least three months as of September was 0.29 per cent, or 11,362 of about 3.9 million mortgages in the country. Arrears in the U.S. are 6.5 times higher.

"Canadian trends are stable. American trends are worsening," according to the bankers' group.

In its report, the Bank of Canada says consumer debt woes will also cut deeply into bank profitability. In their recent financial reports, the six biggest Canadian banks reported a 38 per cent drop in profits for the just completed 2008 fiscal year to about $12 billion.

Much as has happened in the U.S., the central bank officials say the contagion could spread through the banking system and further restrict the availability of credit.

The Bank of Canada does caution that the vulnerability of Canada's housing sector should not be overstated.

It notes that lending practices in Canada have been far more conservative than those in the U.S. and that subprime mortgages account for about five per cent of the market as opposed to 14 per cent in the U.S. Banks are also insulated for defaults through government guaranteed mortgage insurance.

As well, although debt is high, low interest rates means that at present most households are able to comfortably manage their financial obligations.

Merrill Lynch economists David Wolf and Carolyn Kwan warned back in September that Canada was experiencing a similar housing meltdown as occurred in the U.S.

But Derek Holt of Scotia Capital agreed with the Bank of Canada that the situation here is not as dire.

"If we start off by looking at the household balance sheet it's 20 cents in debt for dollar of assets in Canada versus 26 cents in the United States. So we have 30 per cent less debt per each dollar," he explained.

Housing market

Canadian housing starts fell to 172,000 at a seasonally adjusted annual rate last month, down from 211,800 in October, Canada Mortgage and Housing Corp. reported Monday.

The rate of urban starts decreased 21.6 per cent month-over-month to 144,800 in November, with declines in all parts of the country as volatile multiple starts tumbled 29.1 per cent to 81,700 while single-family starts eased 9.0 per cent to 63,100.

The November numbers "remain consistent with our forecast, which calls for more moderate activity of 212,000 units this year and 178,000 units next year," commented CMHC economist Bob Dugan.

"Note that at the beginning of the new millennium, Canada posted strong housing start levels given a pent-up demand that existed then. Over the last few years, this excess demand gradually decreased and our forecast for 2008 and 2009 reflects this new reality, with housing starts more aligned with long run demographic demand."

For the first 11 months of 2008, total residential construction starts were down 7.6 per cent compared with the corresponding period of last year, with urban single starts down 18.4 per cent but multiple-unit starts up 8.6 per cent.

The CMHC numbers concide with a Royal Bank report saying the housing sector is entering a cyclical downturn but the risk of a U.S.-style meltdown is remote.

RBC senior economist Robert Hogue says many factors that triggered the U.S. housing collapse are absent or much less evident in Canada.

He predicts the housing market will hold up even as a sluggish economy threatens income growth and erodes consumer confidence, because subprime mortgages are not prevalent in Canada, while the banks are stable and households are generally not overstretched financially.

"These factors should provide enough of a foundation to prevent housing markets from spiralling down even as the Canadian economy slips into recession," Hogue added.

Mortgage rates dropped by 2 Canadian banks

Two Canadian banks did their bit to unclog the country's constricted housing market Wednesday by cutting mortgage rates.

The Royal Bank of Canada and the Bank of Montreal both chopped borrowing costs for people seeking to buy a home.

RBC cut its mortgage rates by one-quarter of a percentage point for most of its loans with terms ranging from six months to 25 years.

The exceptions were the one-year closed and four-year closed mortgages. Both of those products saw their rates slashed by three-quarters of a percentage point. The one-year vehicle now costs 5.60 per cent while the four-year mortgage rate is 6.29 per cent.

BMO marched down a similar path but at a different pace.

A three-year variable-rate mortgage from the chartered bank now has an interest rate 50 basis points lower at 5.0 per cent.

In its biggest move, BMO knocked the rate on its one-year fixed closed mortgage by 1.05 per cent to 5.60 per cent. The only three-year mortgage making the RBC list was closed, with an interest rate of 6.45 per cent.

Interest rates have been falling as central banks cut prime lending charges and pumped trillions into the global financial system in an effort to get lenders lending and borrowers borrowing once again.

To some degree, rates have fallen as the financial crisis gained momentum.

According to the Bank of Canada, a one-year conventional mortgage had an average interest rate over the past 20 months of 6.94 per cent. That compares with a current rate for the same borrowing vehicle of 6.35 per cent.

In many cases, lenders try to match the terms of their lending with the conditions regarding the cash they in turn borrow to fund the mortgage.

Thus, to fund a five-year mortgage, a bank might issue a similar-length bond.

So the comparable rate for long-term mortgages might be the lengthier GIC or government of Canada bond. And these investment vehicles tend to have higher interest rates than GICs or bonds of a shorter duration.