The Canadian housing market is about 20% overvalued, estimates Fitch Ratings in a new model for assessing residential mortgage losses.
The rating agency issued an exposure draft detailing its new loan-level model for estimating losses on prime Canadian residential mortgage pools, which was developed to assess the credit risk of residential mortgage loans collateralizing various securities under different home price and macroeconomic scenarios.
According to a report setting out the new model, Fitch estimates that prices are “overvalued by approximately 20% in real terms across Canada, with regional variations.”
Due to inflation and price momentum, it is not expected that prices would drop by this amount, Fitch says. “If growth halted and prices began to drop, it would be expected to take several years for home prices to revert to their sustainable values, depending on a number of factors such as government support and credit availability. With this timeframe, the actual observed decline in prices could be as low as 10%,” it suggests.
The report notes that the Canadian banking system remains one of the soundest in the world, however, it says elevated household indebtedness has rendered Canada’s economy more vulnerable to adverse shocks, particularly those affecting employment. It points out that, since 2000, the ratio of household debt to disposable income in Canada has increased more than 50% and remained at its high of more than 160% in the third quarter of 2012. “For the first time Canadian households have become more leveraged than their U.S. counterparts,” it says.
“Borrower leverage is roughly 80% higher than it was during the recession of the early 1990s, in which house prices experienced only modest declines despite unemployment reaching a high of 11%. As such, Canadian consumers today are more vulnerable to external economic shocks such as a sustained increase in unemployment or sharp rise in interest rates,” it says.
The government has taken steps over the past year to curb the growth in mortgage credit, which Fitch says, “seem[s] to have slowed home price growth without causing a severe correction in prices.”
Fitch projects economic growth in Canada to average 2.0% per year through 2014; unemployment is expected to decline to 7.2% by the end 2014, it says. Short-term interest rates are also expected to remain low, it notes.
Comments on the new model are sought by March 29, and Fitch expects to finalize it in April.