Sunday, June 3, 2012

Welcome to Canada's Future - Lessons That We Can Learn From America

Over the past five years, we've all heard stories from the United States regarding the use of residential real estate as an ATM.  That story didn't end well, did it?  From what we're seeing in Canada, this could well be our future.

To put Canada’s current credit and housing situation into perspective, let's take a quick look at data from the Federal Reserve Bank of New York as published in their recently released Quarterly Report on Household Debt and Credit for the first quarter of 2012.  

Here is a graph showing the rapid rise in total consumer credit from the first quarter of 2003 and the drop in outstanding credit from the middle of 2008 onward:


Notice the little purple wedge?  That shows the growth in HELOCs or Home Equity Lines of Credit.  That wedge is showing the use of residential real estate as a money-creating machine, a machine that gave the illusion of wealth to home owners.  While the graph doesn't show it very well, the size of HELOC indebtedness has actually dropped by 14.3 percent from its peak in 2008 after a dramatic rise from 2003.  Household mortgages (in orange) have also dropped by 11.9 percent from their peaks in 2008.

Here is an interesting if not slightly scary (but rather pretty) graph:


This graph shows the delinquency status for loans of all types with the most seriously delinquent loans in red-orange and the current or non-delinquent loans in dark green.  Way back in the wonder years of 2003 to 2007, less than 5 percent of all loans were delinquent by 30 days or more.  By the middle of 2009 and early 2010, that had more than doubled to nearly 11 percent.  Right now, 9.3 percent of outstanding debt is in some stage of delinquency totalling $1.06 trillion, down from 9.8 percent just three months earlier.  More than $796 billion worth of loans are considered seriously delinquent; these are the loans that are at least 90 days late.

Here is a graph showing the percentage of loan types that are more than 90 days delinquent:


Notice the purple line?  That line represents HELOCs.  Up until the beginning of 2006, holders of HELOCs were basically non-delinquent.  That is for one reason alone as shown on this graph:


That's right, it was the seeming never-ending rise in housing prices that kept HELOC borrowers current.  As the value of housing rose, homeowners kept borrowing against the rising value of the properties that they were renting from their local bank.  HELOC delinquencies quickly rose to just under 5 percent and show no sign of declining any time soon.  In sharp contrast, despite the massive number of foreclosures in the United States, you'll notice that even the number of seriously delinquent mortgages has dropped from around 9 percent to around 7 percent.  

Lastly, let's look at a graph that shows the number of new foreclosures and bankruptcies since Q1 2003:


You'll notice right away that the number of new foreclosures (in blue) rose very rapidly starting in mid-2006 and only began to drop at the end of 2010.  Even now, the number of new foreclosures is well above normal inter-recessional levels.  Welcome to Canada's future.

Now, let's look at Canada's credit situation shown in these two graphs:




Now that we've seen the corner that Canadian borrowers are backing themselves into, let's look at how one Canadian bank is handling the looming debt crisis in light of the fact that right now, 9.3 percent of loans in the United States are in some stage of delinquency.  At the end of 2011, TD Bank had $73,601 million worth of residential mortgages and $97,512 million worth of consumer and personal credit.  Of this, only $331 million of residential mortgages were considered "impaired", only 0.45 percent of the total outstanding.  As well, only $361 million of the consumer and personal credit was considered impaired, only 0.37 percent of the total.  What if TD Bank ended up in a situation where the real estate market collapsed as it did in the United States and consumers ended up well underwater?  TD Bank has set aside $1,465 million as a provision for credit losses or 0.856 percent of all outstanding mortgage and consumer debt.  That is a far cry from what would be required if the Canadian real estate market suffered a major price readjustment.  Right now, the only thing saving the bacon of Canada's banking system is this prolonged period of low interest rates; when consumers find that their monthly payments take a sudden jump to unaffordability, the situation in Canada could mimic what has happened in the United States since 2006 and Canada’s banks could find themselves in possession of a pile of unoccupied residential property.

Canadians and Canada's banks should be learning a lesson from our neighbours to the south.  American real estate consumers were lulled into a false sense of invulnerability.  Such was not the case and unfortunately, millions of American households have paid the very painful price of over-borrowing.  Next up to bat – Canada.

7 comments:

  1. Thanks for the graphs!

    The outstanding student loan growth certainly looks ominous as well.

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  2. Indeed it does. And these unfortunate borrowers haven't even hit the mortgage loan part of their lives yet!

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  3. It is relatively easy ( but painful ) to walk away from mortgage debt in the US -- not so in Canada ( except in Alberta, I believe). So the bloodbath will have a different course in Canada than the US. But still a bloodbath.

    Banking regulation needs to gradually tighten the requirements for mortgage qualifications and more rapidly tighten HELOC loans.

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  4. Not true. Only about 10 states in the U.S are non-recourse.

    Two of the hardest hit states, Florida and Nevada, are both recourse states.

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