Canadians will be spared a U.S.-style wave of foreclosures when the housing market corrects and interest rates rise, according to a report from DBRS Ltd. examining Canada's $1-trillion mortgage market.
DBRS expects housing prices to fall and acknowledges that the soaring trajectory of consumer debt is worrying. But the debt-rating firm's study nonetheless paints a picture of a home lending business that is on much more stable footing than the one in the U.S. before its bust.
For that reason, any housing correction in Canada is likely to have a muted effect on the financial sector, nothing like the systemic problem that the U.S. downturn created by crippling banks and mortgage insurers.
"You're not likely to have factors supporting further [home]price increases; you could have factors leading to price corrections, but they shouldn't be anywhere near the scale we've seen in the U.S.," said study author Jerry Marriott, who specializes in rating mortgage-backed bonds for DBRS.
"There are just some fundamental characteristics of the Canadian market that make lending in Canada less risky than in the U.S. - a combination of the fact that the banks have continued to use prudent underwriting and maintained better capital ratios."
DBRS believes that the market is already cooling, Mr. Marriott said.
The report echoes the conclusions of major banks such as Canadian Imperial Bank of Commerce and Toronto-Dominion Bank. They also call for moderate cooling in house prices after their long runup, as more homes come on the market and higher rates and prices force some buyers out of the market.
CIBC World Markets economist Benjamin Tal said this week that prices might fall by as much as 10 per cent in the next two years, but that a "violent" correction like the United States experienced remains unlikely. TD Bank recently put out a report predicting prices could fall by 2.7 per cent in 2011.
If a correction happens, Mr. Marriott said that it's unlikely Canadian banks will have to foreclose on many mortgages, saving Canada from one of the factors that exacerbated the U.S. plunge, when banks seized homes and tried to sell them at vastly reduced prices.
Laws in Canada are more lender-friendly, forcing people to keep paying mortgages, and banks were more careful about who they lent to.
Canadians are also less likely to end up under water - owing more than their home is worth - because they generally have more equity in their homes. For the decade and a half leading up to the U.S. housing bust, U.S. borrowers had "consistently" less equity than Canadians, by 8 per cent on average, DBRS found.
What's more, DBRS argues that while Canadians are racking up debt at a fast pace, they are nowhere near as indebted as some analysts assert, and much less in hock than Americans, so should better be able to handle the stress of higher rates or a housing correction.
While the widely watched measure of debt-to-personal-disposable income shows that Canadians are more indebted than Americans, DBRS argues that the gauge should be adjusted to reflect differences in the two countries, such as the fact that Americans pay lower taxes but have to pay health-care bills out of pocket.
When that's taken into consideration, at "the end of 2009, Canadian households remained financially less leveraged by 10 per cent to 45 per cent compared with U.S. households," the report said.
"The Canadian market has been doing just fine, but it is not without risk, and [showing that]is what we're trying to do in this study," Mr. Marriott said.