Payment Shock for Some

Steve Saretsky -

We need higher rates to moderate demand, including demand in the housing market. Housing price growth is unsustainably strong in Canada. That was the message from senior deputy governor of the Bank of Canada, Carolyn Rogers this past week. Yes, the central banks continues to talk up further rate hikes, with the goal of slowing housing in the process. As we’ve been talking about in this newsletter for several weeks now, mission accomplished.

Housing activity is slowing at a rapid pace, with further data from the always insightful Ron Butler of Butler Mortgages, confirming what we already know. The 3 Mortgage Insurers in Canada: CMHC, Sagen and Canada Guaranty are down nearly 40% on unit application volume for the month of April. This shouldn’t be surprising considering the lowest 5 year fixed nationally-available uninsured mortgage is now north of 4% for the first time since 2010. Demand destruction is well underway, and house prices are already dropping in parts of the market, mostly in frothy suburban neighbourhoods.

A few things worth keeping an eye on moving forward. Many borrowers are about to see their mortgage rates double this year. You see, alternative lenders like Home Capital and Equitable Group issue the bulk of their mortgage loans on 1-2 year terms. In other words, these borrowers are about to face a payment shock upon renewal. It’s no coincidence that Home Capital Group stock price is down 30% year to date. Now tack on private lending, which is a full step below the alternative lenders and the risk escalates further. Remember, the private lending space has been booming for years off the back of a prolonged housing bull market where both the borrower and the lender have likely miscalculated the downside risks.

There are a lot of risks brewing underneath the surface, and while the Bank of Canada is talking a big game, they are in for a rude awakening when housing activity doesn’t simply “moderate” as they are suggesting, but declines sharply, prompting concerns of declining house prices and financial stability. There are a few likely responses that could coincide with a pause in the rate hiking cycle. Per Rob Mclister, an industry veteran, the department of finance is still strongly considering raising the CMHC mortgage limit from $1M to $1.25M. The fact that this policy change was even on the table for discussion during a bull market is insane, so there’s likely a good chance it gets passed if the market falls and they need to kickstart the engines.

Don’t expect this to happen anytime soon though. Policy makers are always reactive, not proactive. They also take their cues from lagging data, such as the home price index. The most widely published house price index lags by up to 6 months. In other words, year-over-year price declines in the housing market likely won’t show up until 2023, even though, in real time, prices are already coming off in many markets.

Three Things I’m Watching:

1. Mortgage rates for alternative lenders in Canada is rising quickly. This will create renewal risk for some borrowers. (Source: Ben Rabidoux)

2. The sales to new listings ratio in Toronto points to lower prices ahead. (Source: Capital Economics)

3. Rising fuel and food prices risk pushing the economy into a recession, let alone higher interest rates. (Source: David Rosenberg)

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The Saretsky Report. December 2022