Juggling Dynamite

In a September 8th update entitled, Indicators of Financial Vulnerabilities, the Bank of Canada (BOC) notes that in Q1 2023, so-called investors owned 30 percent of mortgaged homes in Canada, up from 20 percent before the pandemic. See, Investors took a bigger chunk of the housing market during the pandemic, data shows.

In the first quarter of 2023, investors owned 40 percent of Canada’s condo market, and most were highly leveraged with a negative cost of carry. During the pandemic, buyers were most likely to leverage existing homes to get downpayments for additional properties—debt on debt on debt.

As explained in the Bank’s 2022 Financial System Review, the presence of leveraged investors tends to amplify price cycles up and then down:

During housing booms, greater demand from investors can add to bidding pressures and intensify price increases. Similarly, when prices are stable or declining, a lower influx of investors can add downward pressure on housing demand and prices.

In January 2023, 30 percent of Canadian mortgages were variable rate, where interest costs have risen in lockstep with central Bank tightening, and fixed rate loans are coming up for game-changing renewals every month.

Many realize they have taken on too much debt and must sell assets.

At the same time, a shrinking number of buyers can qualify for financing at current rates and prices. The number of Canadian mortgages originated in 2023 is the lowest in over a decade (BOC chart below since 2013). Makes mathematical sense. Rising unemployment will dent demand further.

Komal Sri-Kumar, president of Sri-Kumar Global Strategies, joins ‘Squawk Box’ to discuss the Fed’s inflation fight, the state of the U.S. economy, recession outlook, and more. Here is a direct video link.

Bank lending is contracting across world economies. The percentage of US banks tightening their credit to large and medium firms (below since 1990 via Tier 1 Alpha) now above 40%–was only seen during the 2020 pandemic, the 2008 financial crisis, the 2001 Dotcom bust, and the 1990-91 recession.

As higher interest rates freeze existing home sales, builders have enticed new home sales through discounts and mortgage rate buydowns. The 12% decline in the median US new home sale price to 436K in July from 496K last October has only been rivalled during the severe recessions of 1970 and 2008. Prices are back to where they were two years ago, and downward pressure is picking up.

Purchasing power drops 34% to $754k at a mortgage rate of 6% from $1.150 million at 2%. A $603K conventional mortgage (25-year amortization, 20% down) at 6% has the same $3800 monthly payment as an 880K mortgage at 2%.

Not surprisingly, some 60,000 purchase deals for US homes fell through in August, according to the latest report from Redfin. That equals roughly 16% of the homes under contract last month and the biggest share of cancellations since last fall and 2020 before that (chart below since 2017).

August marked the second straight month that Canadian home resales dipped (RBC chart below since 2006). Tight supply conditions ease as the number of homes put up for sale climbs. We concur with RBC’s analysis last week in Housing market stagnation setting in: “We think the cooling trend will extend into the fall season despite the Bank of Canada pausing its rate hike campaign.”

As loan defaults and bad debt provisions mount, Canadian banks are retreating from the consumer loan space. The Bank of Montreal just announced that it’s winding down its retail auto finance business, resulting in an unspecified number of job losses:

The move, applicable in Canada and the United States, comes after BMO’s bad debt provisions in retail trade surged to C$81 million ($60 million) in the quarter ended July 31 compared with a recovery of C$9 million a year ago, in a sign of growing stress consumers face from a rapid rise in borrowing costs.

The deleterious cycle of escalating credit stress, declining economic activity, rising unemployment and falling asset prices has very likely only started.