More mortgage defaults possible, credit firm says

Higher rates, lower prices put some in squeeze

TORONTO • Credit rating agency DBRS Inc. says the recent drop in house prices in the Greater Toronto Area, combined with higher interest rates, could lead to increased mortgage defaults.

In a report Monday, the company notes the average resale price in the GTA has fallen 31 per cent since April — a period that coincides with the introduction of Ontario’s Fair Housing Plan and its 15-per-cent non-resident speculation tax for the Greater Golden Horseshoe, which encompasses a population of nine million people.

While the default risk is up in the GTA, DBRS said other factors will intervene in the market.

“This is expected to be mitigated in part by strong job creation in Ontario, which has seen job gains of 91,000 year-to-date and a reduction in the unemployment rate to 5.7 per cent as of August, 2017, from 6.4 per cent in December, 2016,” the report noted.

DBRS also pointed out that mortgages outstanding grew by 6.3 per cent yearover-year to $1.48 trillion as of June, 2017, up 264.3 per cent from 1999. House prices rose 230 per cent during the period.

“The surge in home prices has made it hard for the average family to qualify for an insured mortgage, particularly in Vancouver and Toronto,” DBRS noted.

The numbers speak for themselves with an average family applying for a 25-year insured mortgage having little chance of making the theoretical average gross debt-service ratio (GDSR). That ratio is calculated as mortgage payments, plus property taxes, plus heating costs divided by annual income.

“Given average market prices and after applying the stress test — (the GDSR) is estimated at 110 per cent in the Greater Vancouver Area and 77 per cent in the GTA, both above the 39-percent cap for debt serviceability set by the Canadian government,” said the rating agency, noting the average estimated GDSR on a national level, without including the GVA and GTA, is 41 per cent.

In the second quarter, Canada Mortgage and Housing Corp. said homebuyers with CMHC-insured mortgages had an actual average GDSR of 26.6 per cent.

The DBRS report seemed to show Canada is mostly a tale of two markets again, but this time the rest of the country is holding up, while Toronto declines and Vancouver recovers. In the last quarter, the average resale price nationally was 2.5-percent lower than a year ago but excluding British Columbia and Ontario, the average resale home price increased by 2.1 per cent. Exclude the GVA and the GTA and that year-over-year increase jumps to 5.2 per cent.

Of note is the recovery in prices in the GVA after British Columbia imposed a 15-per-cent tax on foreign buyers in August, 2016.

“The average resale price in the GVA has recovered from the 17-per-cent fall,” DBRS said, adding prices are still off 2.5 per cent from a year ago in the Vancouver region.

Overall, DBRS said mortgage defaults could end up being tied to unemployment and a drop in home prices.

“Mortgage defaults are highly correlated to unemployment and house price decreases. (There is a) 67-per-cent correlation between annual home price decreases and mortgage defaults, measured from 1990 to 2017 and a 77-per-cent correlation between unemployment and mortgage defaults,” the ratings agency says, adding energy-dependent provinces have been affected by employment issues. “The recent uptick in unemployment in Alberta was followed by an increase in mortgages in arrears.”

The other pressing issue for the market could be a rise in interest rates, a real fear with the Bank of Canada raising its overnight lending rate twice since July and another increase possible in October, moves that have sent the prime lending rate at most banks from 2.7 per cent to 3.2 per cent.

“Despite increasing debt levels, the amount of household disposable income allocated to service mortgages has remained stable since 2008, standing at 6.1 per cent in the second quarter of 2017. The amount of disposable income allocated toward interest payments has continuously decreased, standing at a low of three per cent,” said DBRS, noting increasing amounts of mortgage payments are being applied to amortization of principal.

The real issue for the market would be a sudden rise in interest rates and DBRS says a two-percentage-point increase, based on the fiveyear posted rate, would send the average GDSR to 56 per cent from 48 per cent for Canadians with conventional mortgages of more than 20-per-cent down. Insured mortgages would jump from a GDSR of 55 per cent to 64 per cent — well above the 39-per-cent government limit.

“At current home prices an average family would find it difficult to qualify for a mortgage,” the company, concluded about the interest rate risk. the west end of Toronto.

Sonshine said the REIT has since reviewed every one of its rental projects and has about 20 in the pipeline. The traditional retail landlord will have about 4,000 units in its portfolio as it takes advantage of some of its strategic locations in urban centres.

“Our stated goal is to have 10,000 units across Canada,” he said in an interview, adding his company does not want to switch to condominiums over rentals.

“We are in the cash-flow business and we like cash flow even though the government has put a crimp in future growth.”

Sonshine said the unit was converted to condominiums because it had a partner on the development in Allied REIT, so only half of the 133 units belonged to his REIT, and the price of the condominiums had gone higher than expected.