The Effect of Overt Macroprudential Policy and Interest Rates on Borrowing

A quick and dirty gauge is to ask, given current interest rates and rates used for loan qualification requirements, what is the amount of loan a borrower can get via a conventional mortgage? To answer this, we can normalize for income level and debt-service ratio and look at the effects on maximum loan qualification for both insured and uninsured loans. I have normalized the results to January 2000:

The amount of loan has depended upon macroprudential policies relating to maximum amortization lengths and minimum downpayment ratios. These two have tracked well until 2010 when the government required using posted, not discounted, rates to qualify for government-insured loans. The most recent overt macroprudential measure was to reduce the maximum amortization for an insured loan to 25 years from 30 years. I have assumed uninsured loans can still get 30 year amortizations. 

This is for a generic "prime" borrower; DSR and other qualification limits will be imposed based on lenders' internal risk management policies (that have notably changed of late) that will not show up in this graph above.

Nonetheless it is stark how accommodative uninsured loans are in the current environment, and how stiff the "posted" rate has been since mid-2012 despite the significant pressures on yields. Finance Minister Jim Flaherty recently took to strong-arming banks to ensure they did not change their posted five-year rates. If banks were allowed to lower the posted rate the red line on the graph would be higher.

As it stands in the current environment an insured borrower can qualify for about 33% more loan than was the case in 2000, income-adjusted. An uninsured borrower can now qualify for an impressive 65% more loan.

Upper Body Work on the Five Year

Here are some graphs on the Canadian five year mortgage rates. The first graph is the "posted" and "average" mortgage rates since around 2000:

The components of the mortgage rate are comprised of future inflation expectations (I used the long real return bond and the long bond to estimate future inflation expectations), the real rate of interest on "risk free" (the five year Government of Canada bond yield subtracting inflation expectations), and the residual which we abstract to be the "spread".

The real rate of interest on the five year GoC bond has been negative for over a year now. For the most part this has materialized as increased spreads to mortgage lenders and securitizations. The negative real rate on the five-year bond has been causing consternation with the government and the Bank of Canada and is a major reason why they have been leaning so heavily on mortgage lending over the past year.

The posted and average mortgage rates have diverged over the past few years:

Finally there is the "renewal gap" that takes rates from five years ago and asks the question, what interest rate differential (IRD) will a borrower see upon renewing a five-year mortgage, all else equal? I have estimated the forward-looking renewal gap by keeping current rates constant out until 2018 (five years from now). If that occurs the renewal gap in five years will be exactly zero.

The five-year renewal gap is heavily negative and will remain so until the end of 2013. This will provide some refinance tailwind for housing activity. That tailwind hits a proverbial brick wall in 2014 even if rates remain low. (Note the absolute magnitude, not just the gap, matters for payments. That is, a renewal gap of -1% pre-2008 and post-2008 will have a different effect on changes in absolute payments.) In terms of setting macroprudential policy, I expect the government is considering upcoming renewal IRDs.

February 2013 CMHC Data - Vancouver CMA

Here is the chart for housing starts, completions, and under construction for Vancouver Census Metropolitan Area (CMA) to February 2013 with March 2013 preliminary housing starts:

Below we can see a continued high level of multi-unit construction compared to detached construction. The long-term trend for detached construction is down.

The last three years have seen an increasing amount of starts and under construction volume, the former of which now looks to have crested. Completions are trending upwards, as expected -- completions typically lag starts, so if starts are trending higher that will likely mean completions will trend higher as well. 12 months of completions are now 30% above the trough in 2011. (The actual trough was in early 2011.) With this increased level of completions, and what looks like either a plateaued or further-increasing level of completions into this year, we can expect increased competition among sellers in 2013 compared to 2012.

Despite 2012's resale malaise starts remain healthy, pointing to continued construction activity -- and new supply -- over the coming quarters. Units under construction remain high.

On the unit absorption front here is completed and unabsorbed for single and semi detached dwellings.

BC Employment by Sector March 2013

Below are some graphs highlighting Vancouver's and BC's employment over the past 15 years in various sectors. But first here are the historical employment, participation, and unemployment rates (CANSIM tables 282-0117 and 282-0087)

The participation rate markedly increased last month. Some additional months will be needed to determine if this is noise.

The labour rate spreads between the rest of BC and Vancouver CMA are graphed below. A positive number means the rest of the province has a higher number than Vancouver. In terms of unemployment Vancouver has typically been about 50bps lower than the rest of the province, but lately that differential has been negative.

Here are the contributions of the two major goods producing sectors (construction and manufacturing) as a percentage of total employment. These are seasonally unadjusted with 3 month moving average applied (CANSIM table 282-0111).

Construction employment as a percentage of total employment is near highs of at least the past 20 years. The service producing sectors (NSA) (12 month average):

Greater Vancouver Market Snapshot March 2013

Below are updated sales, inventory and months of inventory graphs for Greater Vancouver to March 2013. (see REBGV news releases.). (My "next month estimate" numbers are what I think next month will be. Also note these graphs update automatically so older blog posts from previous months will show the same graphs as the ones below.)

The scatterplot of price changes and months of inventory is below. As the Teranet data roll in, look for more points appearing the right-hand side. I would not be surprised to see the Teranet HPI down between -6% and -4% year-on-year by February or March of 2013, however the February 2013 reported was -1.5%, which is higher than I expected but not what I would consider anomalous.

Commentary:

March sales continued with relative weakness compared to not only 2011 but also past years from 2005 (except the residual emerging from the recession of 2008-2009). March  sales are near lows in at least the past decade, though above levels seen in 2009. In 2009, April sales vaulted back significantly. It is unclear whether or not we can expect similar behaviour in 2013.

To partially compensate for weekend framing effects I have plotted sales per working day on a month-by-month basis.

This March saw another weak report. Sales for the year are bad and this has direct effects on incomes of those who depend on resale turnover for income. As the months progress it becomes more and more difficult to hit yearly sales targets in-line with those seen in the last decade.

As a recurring reminder, there are some worrying clouds on the horizon: population growth is falling, dwelling completions are set to increase over the next year if not longer, and banks have implemented stricter mortgage guidelines via changes to government-underwritten mortgage insurance qualification criteria and via implementation of stricter mortgage lending guidelines under OSFI's new directives. (Credit Unions are one notable exception though it appears BC CUs will comply with the brunt of OSFI guidelines.) Further stress in current conditions can be attributed to China's slower economic growth, though it looks like growth is set to resume some entering 2013; for how long this growth can continue is uncertain.

On the other hand mortgage rates remain low, near net zero real territory, and it is possible for rates to remain low for a prolonged period (i.e. several years). That stated, longer-term 5-year-term loan rates may have some room to move up in the coming year as the advent of the removal of accommodative overnight rates starts entering the purview of the 5 year time horizon.

Asian economies are currently meting out another round of investment spending through coordinated government stimulus measures -- and not only in Asia but also in other jurisdictions -- and that can plausibly lead to a renewed, but in my view temporary, bout of current account flows into Vancouver-area property investments. Investment trends in China are difficult to ascertain.

My estimates for March were for inventory of 16067 (actual 15460) and sales of 2237 (actual 2347) based on estimating average changes from February of years 2005-2012. Using the same technique estimates inventory and sales for April of 16628 and 2661 respectively (MOI=6.3). March is typically the nadir for MOI in recent years, the exception being 2009 that saw MOI decrease throughout the year. Taking a "hybrid" approach would suggest April's MOI being slightly lower than March's but would exclude a strong rebound.