There has been much talk about a market slump and the prospect of rising unemployment. But there hasn’t been much chatter of what it could mean for a Canadian housing market that has been on fire.
Few people have taken the time to look at how badly a housing correction could hurt, but Paul Holden at CIBC World Markets has done just that through the lens of Genworth MI Canada , the country's largest private mortgage insurer with $240-billion of insurance in-force. The analysis is interesting not only for what it predicts for Genworth, but also for what it implies about how much publicly owned Canada Mortage and Housing Corp. could be on the hook for if housing prices turn sour.
To start his analysis, Mr. Holden looked at mortgages originated in the last five years, because defaults and delinquencies typically happen in the first few years of a mortgage. (Therefore mortgages originated before 2006 can be assumed to be fairly stable.)
Before going into his numbers, remember that the less Genworth can recover when a house is sold, the greater the insurance claim it has to pay out. On an average insured amount of $270,000 Genworth typically has to pay out $70,000 if the owner defaults.
Currently, Genworth pays $196-million a year in claims. Using that as his base case, Mr. Holden finds that a 5 per cent price correction, but no rise in defaults, would bump this claim amount to $232-million, while a 25 per cent correction and no rise in defaults would send it to $373-million.
Adding some severity, Mr. Holden then found that if defaults rise 8 basis points on top of a 25 cent correction, the claim could total $430-million.
That looks like trouble. But Genworth has some saving graces, even though its core market is first-time home buyers who put down less than 20 per cent. A few years ago, the company stopped insuring investment properties, so 99 per cent of its book is made up of owner-occupied homes. On top of that, the average home value for a Genworth insured mortgage is about 16 per cent lower than the average home price, Mr. Holden notes, while the average household income for one of its insured homes is around 17 per cent above the national average.
Given these fundamentals, even with a 25 per cent home price correction plus a 300 basis point hike in the unemployment rate, which would send delinquencies higher, Genworth would still make about 41 cents per share, Mr. Holden calculates. That’s pretty phenomenal, because while it isn’t much profit, it isn’t a loss.
CMHC’s fundamentals may not be as positive, but Genworth offers some hope that there may not be an insurance disaster if the housing market has a rough correction.