Canadian banks' edge won't last long

Canada’s vaunted conservative banking culture offers its financial institutions a competitive advantage during economic downturns, but the edge they now enjoy over their global counterparts will likely disappear in about a year, says a top U.S. banker.

Robert P. Kelly, chairman and chief executive of Bank of New York Mellon, told a Toronto audience Wednesday that Canadians “should be proud” of their financial system because the “hard-core reality is that it’s a system that works.”

However, the 56-year-old head of the fifth-largest bank in the United States with total assets of US$220-billion, cautioned that while Canadian banks have “a huge competitive advantage right now, you have a window that’ll probably last 12 to 18 months.”

Mr. Kelly’s comments were made during a two-hour panel discussion moderated by John Manley, former deputy prime minister, on how Canada and the United States are managing their financial systems in response to the current credit crisis.

Rick Waugh, CEO of the Bank of Nova Scotia, was the other panelist on the panel, sponsored by the Canada Institute of the Woodrow Wilson International Center.

Mr. Waugh told the blue-chip Bay Street audience that the “Canada brand has never been better,” and acknowledged that it was a good time for the banks to take advantage of the country’s favourable international reputation.

“The American model is broken and the whole world knows that,” he said. “The doors are as wide open as I’ve ever seen. This crisis has created an opportunity and we have a leg up on the Americans.”

Mr. Kelly cited three main reasons for the success of Canada’s banks during the recent financial meltdown. He pointed to the “mess” in the US$18-trillion mortgage market south of the border, securitization markets that went “out of control,” and a “mature, well-run and well-managed financial system” in Canada that does not exist in the United States.

For example, Mr. Kelly, a former vice-chairman at Toronto-Dominion Bank, said the United States does not have a national banking system, and while the regulatory reform package proposed by President Barack Obama last week is “largely a good thing,” it still doesn’t go far enough to consolidate the number of regulators and players in the industry.

For his part, Mr. Waugh credited Canada’s system of “checks and balances” and “good governance” in the public and private sectors.

The head of Scotiabank, the third-largest in Canada by market capital, cited the macroeconomic policies of the Bank of Canada and regulatory oversight of the Office of the Superintendent of Financial Institutions, as well as “good management” practices inside the executive offices of the banks, especially prudent risk and capital management practises, as reasons for the stable financial sector.

“The back-up systems are working even though they may be far from perfect, they are working,” he told the crowd of about 125 people. “There was not one regulation that said, ‘Don’t invest in subprime and don’t invest in toxic assets,’ and yet no financial institution here got in over their heads.”

Still, Mr. Waugh predicted that shareholders will have to recalibrate their expectations because there is still a lot of deleveraging to occur.

“We are resetting a new norm. That means a lower level of absolute profitability, lower level of savings and growth rates,” he warned.

While Mr. Kelly is the latest to heap praise on Canada’s financial system – he joins President Obama and the Geneva-based World Economic Forum – he seemed to caution against smugness.

“Canadians are more conservative by nature and that’s a competitive advantage in a downturn but it’s not a competitive advantage when things are good,” he said.

“Over time, don’t bet against the U.S.,” Mr. Kelly warned, saying there is no greater growth system than U.S. capitalism because it encourages innovation, risk-taking and the rise of the best people to the top of organizations.

“A lot of bad things have happened with the U.S. capitalist system,” Mr. Kelly said. “It’s good to learn from its mistakes, but what’s really hard is to implement the good aspects. Canada is very well-positioned.”

Buy a house in the States

Looking for a U.S. property within walking distance to the beach? How about a five-bedroom home in Cragin, a North Chicago neighborhood 25 minutes from downtown? Just two years ago, these sales pitches might have been accompanied by warnings like: "Hurry, at $500,000, these prices won't last!"


Not today. With transactions scarce, desperate sellers are dropping prices. A three-bedroom, two-bath bungalow in Huntington Beach, Calif., is on the market for US$100,000. That's down US$142,000 from August 2008. Being 2 1/2 kilometres from the beach helps to make up for the vinyl sided-exterior.

And a three-bedroom, two-bathroom home in Fort Washington, Md., a leafy D.C. suburb just outside the Beltway, sold for US$350,000 in January of 2007, a huge flip from its $120,000 sales price in 2002. That it's currently listed for US$74,900 should be a sign of a serious seller.

Such prices allow select buyers to use their credit cards to purchase them. Today, even with credit tight, American Express (nyse: AXP), Visa (nyse: V) and MasterCard (nyse: MA) offer cards with a US$100,000 limit, and often more, to those with an outstanding credit score. For most cities and regions, $100,000 is a shockingly low figure representing a major drop from the height of the market. Of homes currently listed, a total of US$27.4 billion has been slashed from their original asking prices.

Most sellers won't take plastic, but they will accept cash. For someone who isn't liquid enough to have US$100,000 cash, but doesn't want to miss out on a steal of a deal, taking out a cash advance can be a useful alternative. Given interest rates on credit cards, however, this should only be considered if you'll be able to pay off the debt within a few months.

With that in mind, we looked across the United States for 10 homes that could be had for under US$100,000, but weren't properties in dilapidated, far-flung neighborhoods.

Homes in the Western U.S.—states past Colorado—are selling at a US$276,000 median price, down from $350,000 in 2006, and fell 20 per cent in the past year, according to the National Association of Realtors (NAR). There, you'll find a handful of the properties on our list. There's a US$74,990 three-bedroom, two-bathroom home in the Phoenix suburb of Avondale, which sold in 2006 for US$250,000. In the Seattle suburb of Mill Creek, Wash., a three-bedroom, 1,858 square-foot home is listed for US$87,296. It was sold for US$386,239 in 2006.

It's a similar story elsewhere. While the US$15,000, three-bedroom, ranch home in Detroit could use a lot of work—as well as a new neighborhood—plenty of the homes we found, such as a US$53,000 Dallas home, near Laurel Land Memorial Park, that has front and rear yards, a garage, a patio and three bedrooms are move-in ready.

Often, homes at these prices are either in foreclosure or are distressed. That means that while the asking price is likely negotiable, many are being sold "as-is," in which the seller doesn't have to fix any flaws before the sale.

This is an important caveat. That's because, even though Federal Housing Administration mortgages, a product designed for first-time home buyers at the entry level, comprise 25 per cent of the market, according to the Department of Housing and Urban Development, some sellers are nervous that their properties won't make it through the qualification process, either due to defects or code problems.

"We're seeing lots of sellers taking lower bids instead of accepting buyers with FHA mortgages," says Glenn Kelman, chief executive of Redfin, a national real estate brokerage. "The sellers are worried they won't meet the FHA requirements and are willing to take less."

Another important note: While sellers are taking huge discounts to move inventory—home sales in April rose 3 per cent according to the NAR—this isn't necessarily a sign of a recovery. A full 45 per cent of those sales were foreclosures and short-sales, where sellers and investors are desperately unloading unwanted inventory. Translation: Further price drops could be on the horizon.

"Other than first-time home buyers and investors that can pay cash, much of the housing market is still dead and that spells trouble for housing prices," says Anthony Sanders, a professor of real estate finance at George Mason University. "The recent call for a turnaround is like watching Macy's have a clearance sale—80 per cent off of sticker—for overstocked inventory. Sure, their sales increase. But clearing overstocked inventory is not a sign of recovery for new clothing lines."

Mortgage penalties

Sarah Cervinka and her sister bought a condo in late 2007 and took out a five-year mortgage with President's Choice Financial.

At the time, they were told they would pay three months' interest – about $5,000, in their case – as a penalty to get out of the mortgage early.

Her sister lost her job and did not find another one. Unable to carry the mortgage on one salary, they sold the condo last month.

That's when they called the lender and learned the penalty to break the mortgage was now $20,000.

She felt misled because she had not been warned about the prospect of a much higher penalty.

"Any gains we may have made are now being absorbed into an interest debt that we did not agree to pay nor anticipate," she said.

Most lenders charge three months' interest or an interest rate differential (IRD), whichever is higher. With rates falling sharply, the IRD penalty will be higher.

"Early prepayment charges are outlined and disclosed in the documentation provided to clients when they take a new mortgage," said Rob McLeod, a spokesman for CIBC (a partner with Loblaw Companies in PC Financial).

"It is always advisable for mortgage holders to check with their financial institution about any penalties that may apply prior to taking a decision to sell their home.

"In this case, the client did not contact us prior to agreeing to sell the property."

The topic of mortgage penalties has attracted lots of reader mail.

Many borrowers talked of their frustration in trying to firm up the cost of prepayment when interest rates kept coming down.

That trend may have reversed itself this week. Most big banks have raised their five-year mortgage rates because of a spike in long-term bond yields.

Mary: "I have a five-year closed mortgage and was quoted a $2,000 penalty in April. A week later, rates had dropped and my penalty had doubled to $4,000.

Marc: "My wife and I had to put our house on the market. Our early payout penalty, already absurdly high at $14,000, has been raised to $24,000.

"Unless we get exactly what we're asking for, we'll end up owing the bank money when it's all done."

Randy: "My ex-wife and I have finally sold our home. Four months ago, the penalty was $4,000. Now it's $14,500. If rates go down again by our July closing, it could get up to $20,000."

Susan: "In 2007, I became ill and was confined to a wheelchair, unable to work. My husband, three kids and I had to live on one income for more than a year.

"We put our house up for sale, hoping it would pay our huge debt. We let our bank know and were never told we had to pay a penalty.

"Finally after a year, we have a buyer. We called the bank and found we have to pay $7,000. We never accounted for this penalty in our sale price."

Susan's story had a happier ending after she went to the media. TD Canada Trust agreed to cover her penalty – perhaps because she did call before selling and the bank missed the chance to mention it.

"We are thinking of other ways we can help her as well," said TD spokeswoman Kelly Hechler.

The lesson: Getting out early can cost you plenty, so check with the lender before doing anything. And if you face financial hardship, don't be afraid to say so. You may qualify for help.

Banks boost mortgage rates

Canada's biggest banks are hiking key mortgage rates at a time when the bond market is worried about risk and the longer-term threat of inflation.

Royal Bank of Canada, Bank of Montreal, Toronto-Dominion Bank, Bank of Nova Scotia and Canadian Imperial Bank of Commerce increased their posted rates on five-year, fixed-rate mortgages by 0.2 per cent to 5.45 per cent. The changes at RBC and BMO took effect yesterday, while new rates at TD, Scotiabank and CIBC will be available today.

RBC, BMO and Scotiabank, however, also have "special offers" on five-year closed mortgages at 4.15 per cent. Those promotional rates, subject to change without notice, also reflect a 0.2 per cent increase.

Mortgage broker says rates are rising from "abnormally low" levels. Consumers, still have plenty of opportunity to take advantage of lower borrowing costs because not all lenders have repriced loans.

"Even lenders that we were told were going to increase still haven't," . That means both first-time homebuyers and those with mortgages coming up for renewal can still snag deals.

But, U can still get the best rates "On a quick close (within 30 days) we can still get 3.69 (per cent). On a 120-day rate hold, we can still get 3.79 (per cent)."

Five-year, fixed-rate mortgages are traditionally the most popular option for homeowners. Borrowing costs on the bond market largely influence consumer rates.

Yields on longer-term bonds have soared in recent weeks, driving up the cost of borrowing for lenders. Experts say yields are rising because the bond market is focusing on risk and the future prospects for inflation.

Central banks usually try to control inflation by raising interest rates. The Bank of Canada's overnight rate is currently sitting at 0.25 per cent and it has signalled plans to hold it there well into 2010, depending on inflation.

The bond market, though, sees a risk that interest rates may change down the road, said TD economist Grant Bishop.

"Certainly there is the recognition that interest rates are going to have to go up both because of the need to rein some of this monetary stimulus in – once the economy gains traction – and the level of debt that is being issued by governments."

Yields are also climbing because the market is "a little less pessimistic" about the economic outlook, said David Power, a vice-president in RBC's corporate treasury department. If bond yields continue to rise, that will impact the industry's pricing of both mortgages and deposits, he said.

Statistics Canada, meanwhile, reported yesterday that household demand for credit dropped "significantly" in the first quarter. Household demand for funds in the January-to-March period totalled $65 billion, down from $91 billion in the fourth quarter of 2008. Canadians, it seems, opted to save rather than spend.

"Despite the decrease in the five-year mortgage rate, net new mortgage borrowing also contracted during the first three months of 2009, as investment in residential construction and activity in the resale housing market continued to decline," StatsCan said.

Bank of Canada data, meanwhile, suggest household credit rose 1.1 per cent in April over March, mostly with growth in mortgages and lines of credit. "Even through these uncertain economic times, falling house prices and favourable mortgage rates appear to have successfully attracted new homebuyers," TD's Bishop noted last week.