Canada is in bubble territory
Bank of America Merrill Lynch analysts Sheryl King and Ryan Bohren believe Canadian housing is “in bubble territory” with commensurate “down-side risks remain despite an accelerating economy.” They are not, however, predicting a Canadian real estate crash.
How is Canada different than America?
The Canadian mortgage industry is quite different than the American structure. According to King and Bohren, there are four key differences that give Canadians somewhat of a safety net:
- We find government guaranteed mortgage insurance mitigates risk to financial institutions. Unlike the US where financial institutions were clearly over exposed and the solvency of insurance providers were questionable. 75% of mortgages in Canada are fully insured with Government guarantees and all mortgages with an LTV higher than 80% must be insured by regulated lenders.
- Legal recourse laws reduce the risk of households walking away from their mortgage and implicitly improve lending quality, unlike the US where reports of abandoned vacant homes were and remain rampant. By our estimation around 90% of mortgages are full recourse in Canada, creating a more lender-friendly environment.
- About 30% of the mortgage funding market has a federal government guarantee, which likely reduces the risk of a US style funding freeze. Indeed during the height of the credit crisis, the Government of Canada initiated a very effective Insured Mortgage Purchase Program which essentially kept the Canadian mortgage market functioning.
- Canadian’s have historically held lower leverage ratios than their US counter parts and tend to gravitate to more conservative mortgage options. Canadian household balance sheets have deteriorated and have been treading into more risky areas like variable rate mortgages, but sub prime lending remains a virtually non-existent market in Canada.
To our Canadian readers, do you think the market is in bubble territory or does your structure safe guard you from a bust?