We are still rebounding from the mortgage meltdown. However, our neighbor to the north, Canada did not have the housing debacle that we did. So, why was Canada immune? Here’s what Frank T. Pallotta, CEO at CMF Management Company, LLC, said about this topic:
Q: Canada never experienced any of the housing tumult that the U.S. went through. What did our friends to the north do correctly that we didn’t?
Frank T. Pallotta: It’s true that Canada did not experience the tumult we saw here in the US. More specifically, Canada did not experience the extremely high levels of both negative equity and mortgage losses we saw here in the states. There are a number of reasons why this is the case, but the overriding reason has almost everything to do with “common sense underwriting.”
When the housing bubble burst in the US in 2007, home values dropped (on average) 32% to approximately 2001 levels – though we did see much worse in some areas of the country. Coincidentally (or not), 2001 also saw the widespread use of stated income documentation, and the no-money-down loan. When the music stopped, the borrowers who put little to no money down, defaulted first (and fast), while borrowers with equity in their homes found a way to stay in their home. Negative equity has always been the main driver of default.
Canada on the other hand, never fully embraced the “no money down” notion. Therefore when the housing market started to stumble in Canada, the fact that most borrowers have substantial equity in their homes (and a legal system that does not allow delinquent borrowers to stay in their home for years), is the main reason the Canadian housing “stumble” didn’t turn into a full-blown “collapse.”
Q: How would you categorize the current Canadian housing market? And where do you see its strongest points and potential problem areas?
Frank T. Pallotta: The Canadian housing market in my opinion, appears to be stable with a room to grow. While some economists estimate that the Canadian housing market could be overvalued by as much as 30% (or more), I believe they are wrong and are focused on outdated metrics like price-to-income and price-to-rent ratios which don’t necessarily take into account the significant declines in interest rates we’ve experienced over the past two decades. Remember, a “bubble” in not necessarily categorized as such, simply because prices rise. When home prices rise for the right reason, then there is no reason to think that those increases shouldn’t be sustainable for the long term.
Canada’s best argument for long-term, sustainable housing stability point mainly to three things:
>> Common-sense and sound historical underwriting that appear to balance risk, rate, LTV’s, and documentation in precisely the right combination
>> A legal environment that protects the borrower, the lender AND the investor in a cohesive, just and fair fashion
>> A regulatory construct that is conducive to widespread capital market participation and liquidity
As far as potential problems go, Canadian delinquency rates tend to move nearly “lock-step” with unemployment rates, which appear to be falling. However, there are still many areas of Canada whose economies are tied to commodities that could make them somewhat vulnerable (though historically low LTV’s still leave a lot of protection).
Q: Since there is no Canadian equivalent of the GSEs, how does the Canadian government approach the subject of secondary marketing?
Frank T. Pallotta: “Insured” mortgages in Canada are in fact guaranteed by Canada Mortgage and Housing Corp. (CMHC), a federal agency (CHMC is the equivalent to the US GSEs). However, there is no “active” trading market of that paper (similar to FNMA and Freddie Mac pass through’ s). While the Canadian government appears to regularly monitor liquidity, exposure and risk in the residential markets; an active and robust secondary market doesn’t appear to be as important as a stable and secure housing market.
Q: How do you foresee the state of Canadian housing in 2015?
Frank T. Pallotta: I see the state of Canadian housing in 2015, similar to what we’ve seen over the past 5 years in Canada: stable growth, predictable performance and adequate liquidity. As long as Canadian regulators continue to closely monitor the activities all the participants in a mortgage transaction (bank and non-bank lenders, insurers, borrowers and investors) and act in the best interests of all, the Canadian housing market will remain stable.
The best thing to happen to the Canadian housing market over the past 6 years was the implosion of the US housing market. Not because they had to change anything they did wrong; but because it taught them that they had been doing everything right. Slow and steady always wins the race.
Phil Hall has been (among other things) a United Nations-based radio journalist, the president of a public relations and marketing agency, a financial magazine editor, the author of six books and a horror movie actor. Also, as you will discover, he is not shy about stating his views.