Rising mortgage debt rendering ‘Canadian households stretched thin’: DBRS

Barry Critchley

DBRS, the Canadian headquartered credit rating agency, has joined a long list of organizations that have weighed in on the matter of the Canadian residential housing market.

Like many of those previous studies and against the background of concerns being raised by the federal government and the Bank of Canada, DBRS found some positive — and negative — aspects about the sector that seems to consume Canadians. And with good reason: in many cases, the family home is the largest source of household wealth.

For instance, despite record high levels of household debt, DBRS argued that Canadian households have net worth that could withstand a property value decline of 40%.

But “rising household financial leverage and reduced affordability are of concern, rendering Canadian households stretched thin and vulnerable to liquidity shock or cash flow shortage, such as loss of income or unexpected expenses,” wrote DBRS.

At the end of 2011, Canadian mortgage lending amounted to $1.1-trillion — or more than double what it was a decade earlier. Add in home equity lines of credit and outstanding mortgage-related debt was about $1.3-trillion.

Along with rising mortgage and consumer debt, average house prices are now 4.9 times average gross family income — a level that would require Canadian household to allocate 37% of its pre-tax income to housing-related costs — the so-called “housing affordability ratio.” (House prices have risen faster than average household income.)

DBRS noted that the 37% ratio “is aided by the low interest rate environment and is only slightly worse than the long-term average.” But if interest rates were to jump by 2% the ratio could rise to 43% or more of pre-tax income. “Adding in other household expenses and payments, the average household is left with little residual cash flow or savings,” it said.

Affordability measurements based on national average values “are misleading and do not consider regional or market-specific preferences, differences or even property types,” DBRS said.

Accordingly and “barring a nationwide economic contraction, the real estate market for most Canadian cities appears balanced based on sales activities or housing inventory supply, but moderately overvalued based on the price-to-average income or affordability ratio, with potential overvaluations or pockets of vulnerability in certain markets and segments.”

So what are the big levers?

DBRS said that “a combination of higher interest rates, lower property values and a drastic increase in unemployment would be of great concern as mortgage defaults are closely related to employment and individual family situations.”