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Mortgage rules to sink home prices, deter use of houses ‘as ATMs’ Add to ...

These are stories Report on Business is following Thursday, June 21, 2012.

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Flaherty moves on mortgages
The Canadian government continues to move aggressively to cool down the mortgage market amid fears in some quarters of a bubble in the making, at the same time deterring homeowners from using their properties "as ATMs."

As The Globe and Mail's Bill Curry, Grant Robertson and Tara Perkins report today, Finance Minister Jim Flaherty is acting for the fourth time, reducing the maximum amortization for a government-insured mortgage to 25 years from 30 years. He's also reducing the amount of equity homeowners can take out of their homes in a refinancing to 80 per cent from 85 per cent. The changes take effect July 9.

Canada's bank regulator, the Office of the Superintendent of Financial Institutions, has also acted already, and unveiled the final guidelines today.

This comes amid concerns that the market is overheated, notably in major cities like Vancouver and Toronto, and as Canadian consumers carry ever higher debt burdens, even though loan growth is slowing.

Mr. Flaherty is "prudently taking out some insurance" with today's move, said chief economist Craig Alexander of Toronto-Dominion Bank, by gently tapping the brakes.

Debt growth in Canada has slowed, but is still eclipsing income growth, a threat to the economy should it continue. The ratio of debt to personal disposable income among Canadian households has climbed to a startling 152 per cent. Had steps not already been taken, TD believes, that would have climbed already to 160 per cent, the level that sparked troubles in the United States and Britain.

Mr. Alexander says the cumulative impact of both of today's moves by Mr. Flaherty and OSFI should be to reduce house prices by five percentage points from where they otherwise would have been, and sales by 10 percentage points. That takes more than a year to filter through, Mr. Alexander said, and is based on all else being equal. What he means is that the move could, for example, lead to lower sales listings, in turn tempering a price decline.

Bank of Canada Governor Mark Carney has warned repeatedly of the threat to consumers should there be another financial shock and rising unemployment. Some observers had believed that the run-up in debt could force him to hike rates, but, with Mr. Flaherty's action today, the central bank chief now has more wiggle room to hold rates as he sees fit amid the mounting global uncertainty.

"These latest steps to tighten mortgage rules are part of efforts to avoid one of the negative side effects of having very low interest rates for a long time," said chief economist Avery Shenfeld of CIBC World Markets, which believes Mr. Carney won't hike his benchmark lending rate until 2014.

"With the economy not strong enough overall to deal with a significant ramp-up in rates, it make sense to use alternative targetted measures to address one of those issues, the risks of a bubble in home prices and associated mortgage debt," Mr. Shenfeld said. "These latest moves are just some further fine tuning, but we are already seeing a cooling in house price inflation, and a slower pace to consumer debt. If these measures add to the cooling in housing, it will take the pressure off Carney to use the blunter instrument of interest rate hikes to meet that objective, leaving other parts of the economy, including business capital spending, still getting a much needed boost."

In Halifax, Mr. Carney said the move will support the "long-term stability" of real estate and help guard against the risks associated with swollen debt levels.

Robert Kavcic of BMO Nesbitt Burns says the reduction in the maximum amortization period is equivalent to an increase in mortgage rates of about 0.9 of a percentage point. (That assumes a five-year fixed mortgage rate of 3.3 per cent on a $290,000 mortgage, after a 20-per-cent down payment on an average home.)

"Notably, the impact is bigger than the switch from 35- to 30-year mortgages, which at current mortgage rates, would be equivalent to about 0.6 percentage points of tightening," Mr. Kavcic said.

"It’s also important to keep in mind that the amortization change won’t impact affordability across the entire market, but rather those that would be taking a 30-year amortization," he added.

"As we’ve observed around prior mortgage rule changes, some housing market activity will likely be pulled forward ahead of the implementation date ... with a subsequent payback thereafter. After the 35-year amortization was eliminated last March, for example, existing home sales fell by more than 3 per cent over the subsequent two months."

As for lowering the levels on refinancing, "this is designed to modestly deter homeowners from using their homes as ATMs," said senior economist Michael Gregory of BMO Nesbitt Burns.

"It should result in lower average mortgage balances and higher home equity positions than would otherwise be the case, both of which should help promote financial stability," he said.

Mr. Alexander described Mr. Flaherty's action as a "very constructive step." It shows, he added, that the Canadian government agrees with the Bank of Canada that real estate valuations and debt loads are out of hand.

The combined moves, equivalent to hiking mortgage rates by between 1.5 and 2 percentage points, should cut between one-third and one-half of the overvaluation in the Canadian real estate market, Mr. Alexander said.

"With respect to recent indicators and the need for such measures, resale house sales activity through the first five months of the year is 7.5 per cent higher than over the same period last year," said Mark Chandler, chief of fixed income and currency research at RBC Dominion Securities.

"However, price pressures have abated considerably, with weighted residential prices up just 1.1 per cent on a year-ago basis ... Mortgage credit growth has slowed somewhat as well, though still remains above the pace of personal disposable income (BoC estimates growth at 6.9 per cent on a year-ago basis as of April, the annualized three-month trend is at 6.3 per cent)."

All in all, said senior economist Robert Hogue of Royal Bank of Canada, Ottawa has, since the fall of 2008, reversed the looser rules that came into being between 2004 and 2006.

"This latest move by the federal government - its fourth since 2008 - effectively turns back the clock to the pre-2004 state of affairs, resetting mortgage lending rules to more prudent, if conservative, standards," he said.

Today's move, said Adrienne Warren of Bank of Nova Scotia, could spark an initial burst of activity.

"I see it as another move by Ottawa to reinforce cautious lending practices in response to high household debt levels and high home valuations," she said. "The change is significant enough to dampen housing demand and credit growth, though we could see a rush to lock in a 30-year amortization while they are still available."

 

Markets tank
North American markets suffered a bloodbath today, dragged down by fears over the global economy and a Goldman Sachs warning about U.S. stocks.

Toronto's S&P/TSX composite plunged by about 350 points, or 3 per cent, the Dow Jones industrial average by about 250 points, and the S&P 500 by about 30.

Commodities prices also sank, and the Canadian dollar lost almost a penny.

 

Moody's nukes banks
Moody's Investors Service has taken the knife to many of the world's biggest banks, including Royal Bank of Canada.

The ratings agency's move late today affected 15 banks and securities companies with global capital markets operations, Streetwise columnist Tim Kiladze writes.

"All of the banks affected by today's actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities," Greg Bauer, managing director of Moody's Global banking, said in a statement.

"However, they also engage in other, often market leading business activities that are central to Moody's assessment of their credit profiles. These activities can provide important 'shock absorbers' that mitigate the potential volatility of capital markets operations, but they also present unique risks and challenges."

Among those hit were Bank of America Corp., Citigroup Inc., Credit Suisse Group AG, Goldman Sachs Group Inc., HSBC Holdings PLC, JPMorgan Chase & Co., Morgan Stanley, Credit Agricole, Barclays Bank, Deutsche Bank, Société Générale, UBS and Royal Bank of Scotland.

Various ratings were cut by different levels.

RBC's long-term deposit rating fell to Aa3 from Aa1, but it and two others, including HSBC and JPMorgan, are in a more stable group.

"Capital markets operations (and the associated risks) are significant for these firms," Moody's said of that particular group.

"However, these institutions have stronger  buffers, or 'shock absorbers,' than many of their peers in the form of earnings from other, generally more stable businesses. This, combined with their risk management through the financial crisis, has resulted in lower earnings volatility. Capital and structural liquidity are sound for this group, and their direct exposure to stressed European sovereigns and financial institutions is contained."

 

Shoppers weary
Are Canadian shoppers running out of steam?

Retail sales in Canada slipped 0.5 per cent in April, Statistics Canada said today, more than expected. When you strip out autos, sales declined by 0.3 per cent.

"With just one month of data, Q2 retail volumes are now tracking an annualized growth rate of  -3.1 per cent, the weakest since Q1 of 2009," said senior economist Krishen Rangasamy of National Bank Financial. "Note that real consumption growth was below 1 per cent annualized in Q1, the lowest in three years, and April's retail report suggests that consumer weakness extended to the second quarter. That's not surprising, considering that consumer credit growth (year-on-year) is the lowest in almost two decades and the savings rate is at its lowest since 2007."

 

Italy in crosshairs
Forget Greece and Spain, Eric Reguly writes today. Europe's debt crisis story is becoming all about Italy and it’s putting mild-mannered professor and prime minister Mario Monti, the country’s would-be saviour, in the global hot seat, our European correspondent reports from Rome.

Italy, often dismissed as a “peripheral” euro zone country, is anything but. It is the euro zone’s third-largest economy, roughly similar in size to Britain’s and bigger than Canada’s. It is the second biggest manufacturer, after Germany. It is at the very heart of the euro zone and great lover of the common market and common currency. The Treaty of Rome, signed in 1957, is the forerunner to the European Economic Community that begat the European Union and later the euro itself.

As the state economy and finances deteriorate, Mr. Monti is losing popularity and political support as his save-Italy programs come up short. Like Greece, Italy too is running out of time. It needs a deal quickly.

This comes as the euro zone crisis continues to mount. Spain's borrowing costs, for example, climbed at a debt auction again today.

 

China opens doors
China is opening the doors to foreign stock and bond investors.

The decision by the China Securities Regulatory Commission amounts to what The Financial Times calls one of the most significant moves on capital controls in more than 10 years.

Under the change, foreign money managers will be be able to apply for licences with just $500-million (U.S.) of assets under management, and two years of operating history.

The previous regulations required $5-billion and five years.

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