Sub-prime not an issue in Canada

A few weeks back, the talk of the land was China and its decision to slow its growth rate. Markets tumbled and then cautiously crawled higher. The latest concern is with the stability of the sub-prime lending market n the U.S., and markets have again begun to crumble.

Canada was sideswiped by the first shock because of China’s reliance on commodities, but how does the U.S. sub-prime mortgage market relate here? It doesn’t, says Jim Murphy, president and CEO of the Canadian Association of Accredited Mortgage Professionals (formerly known as the Canadian Institute of Mortgage Brokers and Lenders).

While new mortgage products that are common in the U.S. are finding a place in Canada, the Canadian mortgage market is quite different from that of our U.S. cousins, he says. The vast majority of Canadians tend to be more conservative when it comes to mortgages, opting for shorter amortization periods and longer, more predictable fixed terms when it comes to selecting interest rates.

Also, Canada hasn’t experienced the same aggressive lending practices common in the U.S. “In the U.S., there are tax reasons for having mortgages,” Murphy says, noting that Americans can deduct their mortgages. “Sometimes people want mortgages in the U.S. because there is a tax advantage to them, which is not the case in Canada.”

The numbers illustrate that. The sub-prime market down south accounts for as much as 20% of the market whereas in Canada it accounts for about 5% of all outstanding mortgages.

Also, the arrears rate in Canada is about 0.5% or lower. While Murphy didn’t have the arrears stats from the U.S. on hand, he says its rate has been much higher. “Because our arrears rate is so low, I don’t see an impending meltdown on the horizon by any means,” he says.

The reason the U.S. market is stumbling over the sub-prime mortgages is because interest rates are higher and many people who subscribe to a sub-prime mortgage simply aren’t suited for the product.

In some markets in the U.S., borrowers have taken out an extreme sub-prime product with payments lower than value of accrued interest. Not only are their regular payments not making a dent in the principal of the mortgage, but the interest is piling up faster than they can pay it down.

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The effects are already visible. “Risky assets, whether they are sub-prime mortgages or small cap stocks or low quality corporate bonds, have just reached prices that were not justified by micro- or macroeconomic factors,” says Ian Riach, co-manager of Bissett Multinational Growth Fund.

“A lot of the refinancing took place a few years ago, and consumers were locking in very low, sometimes at sub-4% rates for 30 years. A lot of them are able to weather this storm.”

At the same time, a number of people who were attracted to these products because of the low interest rates are finding that their mortgages are coming due and that the rates are much higher, adds Murphy.

“The unfortunate part of this is that it will have an effect on some first-time homebuyers that maybe can no longer access this market, so liquidity might dry up there,” says Riach. “It’s just a symptom of the housing market slowing down or falling off a little in the U.S., which is going to have a ripple effect on not only the mortgage market but some of the consumer-oriented sectors — but I don’t think the sky is falling.”

In terms of the impact this will have on the U.S. economy, Riach suggests it will be minimal since consumers at the lower-income end make up a large number of the foreclosures.

Closer to home, Murphy is trying to deflect the negative connotation associated with sub-prime products. “There is a market for sub-prime,” he says. “Generally speaking, it is for self-employed people whose income may vary from year to year; it’s new Canadians who may not have a credit history and these people…still want to get into the home ownership market and build equity.”

The sub-prime market provides an option to own a home sooner, but Murphy stresses it’s not for everybody. He says that it’s not fair to lump the U.S. experience with Canada’s. “The vast majority of Canadians who have sub-prime mortgages in Canada are paying them.”

It’s clear the fallout in the U.S. is carrying into Canada as several sub-prime lenders have watched their stock prices decrease in recent days.

As for the U.S., Riach says the effects will be longer lasting. “At the margin, some of these lower-quality sub-prime lenders are going to go belly-up, but the larger, higher-quality mortgage companies that do participate in the sub-prime market but have a much more diversified book are going to come through this OK,” he says. “It might even be good for the industry to have this shake out a little bit as it gets rid of a lot of marginal players.”

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(03/16/07)

Mark Brown