thestar.comMay 24, 2012
By Dana Flavelle
Canadian households could withstand as much as a 40 per cent drop in house prices without defaulting on their loans, a report by the debt-rating agency DBRS says.
The agency isn’t saying Canadian house prices are at risk of falling that far, DBRS senior vice-president Kevin Chiang said in an interview.
The figure is the result of conducting “a stress test. A ‘what if?’ The worst case scenario,” Chiang explained. “We’re not saying it will drop 40 per cent.”
Rather, it’s another way of looking at a topic of growing concern among policy makers -- how well debt-laden Canadian households will manage if record low interest rates start to rise or record high house prices started to fall.
Most studies look at debt-to-income ratios. However, this one studied Canadian households’ net worth.
Since the average Canadian household has a net worth of $400,000 and home equity accounts for just $150,000 of that, house prices could fall by up to 40 per cent and households would still be solvent – assuming no other assets declined, Chiang said.
“Average Canadian households are solvent and can withstand a housing price decline of 40 per cent,” according to the report called House Rich, Cash Poor: An Update on Residential Mortgages and Household Borrowing in Canada. “However, increasing household leverage and stretched housing affordability is a concern.”
Despite the recent recession, Canada’s housing and residential mortgage markets have continued to grow since 1990, the report also says.
By the end of 2011, the average home price had appreciated 141 per cent but aggregate national mortgage debt had grown by a much-higher 374 per cent to $1.1 trillion.
Mortgage debt rose faster than house prices because more houses were built during that two-decade period, Chiang explained.
Total household debt, including home equity lines of credit, had grown by 381 per cent to $1.6 trillion.
The faster debt accumulation relative to GDP or average household income drove up both home prices and household debt in Canada.
Between 1990 and 2011, the average home price in Canada increased from 3.4 times the average gross family income to 4.9 times.
Similarly, household debt-to-personal disposal income increased by 73 per cent to 153 per cent, the study found.
The result is reduced housing affordability with pressure on day-to-day cash flow for average Canadian households, leaving them little room to deal with unexpected expenses and more vulnerable to liquidity and cash flow shock.
“However, from the perspective of lenders or investors in securitization, potential losses on defaulted mortgages would be mitigated by household net worth, which includes the equity embedded in the underlying properties, and therefore any rating impact would be subdued,” said Kevin Chiang, senior vice president at DBRS.
The study examines the various sources of mortgage funding in the market, including covered bonds and sovereign-sponsored programs such as NHA-MBS and the Canada Mortgage Bond program, as well as the significant roles played by chartered banks and mortgage insurers.
Another key point of the study centers on the myriad ways used in Canada to assess household financial health and leverage and its implications.
“We would emphasize that affordability measurements based on average numbers are not representative and do not recognize regional or market-specific preferences, differences or property types,” Chiang said.
“Having said that, the real estate market for most Canadian cities appears balanced based on sales activities and housing inventory supply but moderately overvalued in terms of price-to-income and affordability.
“Barring a nationwide economic downturn, the impact of an interest rate increase or any price correction on mortgage defaults should be localized, with more elevated risk in certain markets and segments.”
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