By Mario Toneguzzi,

Published in the Calgary Herald

CIBC report says Canada’s housing market much stronger than U.S. prior to its meltdown.

Canada is not poised for an American-style real estate meltdown, finds a new report released Tuesday by CIBC World Markets.

The report said there are a number of factors that raise concerns about Canada’s housing market, but there are also fundamental differences between the Canadian and U.S. markets that should see a soft landing for the real estate market here.

“To be sure, house prices in Canada will probably fall in the coming year or two, but any comparison to the American market of 2006 reflects deep misunderstanding of the credit landscapes of the pre-crash environment in the U.S. and today’s Canadian market,” said Benjamin Tal, deputy chief economist at CIBC.

According to the most recent Canadian Real Estate Association data on the MLS market, Vancouver led the country in September with an average sale price of $722,681 followed by Toronto ($503,662), the Fraser Valley ($495,096), Victoria ($471,953) and Calgary ($402,756).

Tal said that while the debt-to-income ratio in Canada just broke the American record set in 2006, “this ratio is more a headline grabber than a serious analytical tool. There is a list of countries with comparably higher debt-to-income ratios, which did not experience anything remotely resembling the recent U.S. experience.”

He said the speed at which the debt-to-income ratio is growing is less alarming.

“Comparing the three years heading into the U.S. crash to the past three years in Canada reveals that the debt-to-income ratio in Canada has been rising at half the speed seen in the pre-crash U.S. market,” explained Tal.

The strong growth in indebtedness south of the border was partially fuelled by speculative activity in the housing market — something we’ve seen far less of in the Canadian market. In the decade leading to the crash, housing starts in the U.S. exceeded household formation by nearly 80 per cent. On average, over the past decade, the gap in Canada has been only 10 per cent — with most of the excess seen in cities such as Toronto and Vancouver, said the CIBC report.

It also said another key difference between Canada and the U.S. is in the quality of mortgages. The distribution of credit scores has not changed dramatically in the past four years in Canada which is a very different story to what happened in the U.S. during the four years heading into the recession. Stateside, the proportion in the risky category rose by more than 10 percentage points and accounted for 22 per cent of the overall market.

Tal said many of the troubled mortgages in the U.S. were sold to borrowers with an acceptable credit score but who did not satisfy the underwriting rules for prime loans because they were unable or unwilling to provide full documentation on their mortgage applications. In 2006, these non-prime mortgages accounted for no less than 33 per cent of originations and close to 20 per cent of outstanding mortgages.

“An astonishing one-third of mortgages taken out in 2005 and 2006, before the drop in prices, were in negative equity position, and no less than half had less than five per cent equity, making them highly exposed to even a modest decline in prices,” said Tal. “In Canada, the negative equity position is nil, and only 15-20 per cent of new originations have an equity position of less than 15 per cent. Furthermore, we estimate that the non-conforming market is currently at around seven per cent of mortgage outstanding, up from five per cent in 2005 but dramatically below the over 20 per cent seen in the U.S. at the eve of the crash.

“The reset of no less than $2 trillion of mortgage debt in 2006 and 2007 was no doubt the trigger to the U.S. housing crash. Such a potential trigger does not exist in Canada with mortgage rates likely to rise gradually, allowing borrowers to adjust over time.”

But Tal said home prices are overshooting their fundamentals in large Canadian cities such as Vancouver and Toronto and the recent slowing in sales activity will probably be followed by price adjustments in many cities across the country.

“But the Canada of today is very different than a pre-recession U.S., namely as far as borrower profiles are concerned. Therefore, when it comes to jitters regarding a U.S.-type meltdown here at home, the only thing we have to fear is fear itself,” he said.