The finance minister of Canada’s priciest province for real estate expects new regulations will cool housing appreciation in Vancouver, where there’s already been a marked decline in sales and foreign investment.

“We’ll see a slowdown in the rate at which the value of housing goes up; we may see a modest correction,” British Columbia Finance Minister Michael de Jong saidMonday on Bloomberg TV Canada. “I think it will occur in a managed and orderly way.”

The federal government introduced new rules this month aimed at moderating housing in Toronto and Vancouver, where prices have doubled in the past decade. The moves include a new stress test for buyers and closing a tax loophole used by some offshore buyers. De Jong announced a foreign buyer levy in July, and in September the city of Vancouver said it’s planning a tax on vacant properties starting in January.

Vancouver home sales slipped in August and September, the first two months of data since the 15 percent land transfer tax on offshore buyers came into effect.

Still Rising

Although home sales in the province’s largest city fell 33 percent in September, the most since 2010, prices continued to rise compared with the prior year. The benchmark price of a home, a measure used by the local real estate board, is now C$931,900 ($710,000), up 29 percent from a year earlier.

Foreign investment made up 12 percent of the C$20.6 billion in home transactions in Vancouver from June 10 to Aug. 31, but plunged to less than 1 percent following the tax’s implementation, the British Columbia Ministry of Finance said last month.

The minister said Monday high housing prices are also caused by local demand and a dearth of supply in the city bordered by water and mountains. Applications to build 120,000 housing units are currently before the city seeking approval, he said.

“There’s another part to this equation that we can’t forget and that is supply of building housing,” de Jong said. “That’s something that the private sector has a big role to play and governments need to facilitate at all levels.”

“Let’s not delude ourselves into thinking that the answer to this lies purely within the maneuvering or manipulation of taxation levers,” he said in a separate interview in Bloomberg’s Toronto office.

The new rules will cool the markets in Toronto and Vancouver and improve credit quality, according to the agency.

“Fitch believes that the new measures may temper the housing market, especially in cities that are significantly overvalued,” Fitch said in a report, released Wednesday. “According to a Fitch study published earlier this year, home prices across Canada are estimated to be about 25% above their sustainable value with major regional variations.”

Fitch is supportive of the income tax rule change, which targets foreign owners of real estate.

Under those guidelines, foreign owners are no longer able to take advantage of capitals gains tax exemptions.

“The income tax rule change in particular should reduce housing demand from foreigners. In Vancouver, this will reinforce the effects of the 15% tax on foreign home purchases put in place by the British Columbia government in August,” Fitch said. “Data from the Real Estate Board of Greater Vancouver indicate that average sale prices of detached houses have already dropped by roughly 16%, led by higher priced properties.”

The agency also argued the new guidelines for insured mortgage portfolios could impact non-insured underwriting.

“While insured mortgage loans are prohibited from securing this subsector of the covered bond market, changes to insured mortgage loan underwriting requirements could influence non-insured mortgage loan underwriting requirements. Any tightening of non-insured mortgage loan underwriting requirements would further help to cool the housing market and also help to address the concern of heightened borrower leverage.

While economists are in agreement that federal-level steps such as Finance Minister Bill Morneau’s announcement of new mortgage measures last week are needed to address the affordability situation in the country’s hottest markets, the jury is still out on whether the current approach is too stringent or too timid.

“[Last week’s announcement] is the sixth time in eight years that the government has implemented stricter mortgage regulation, with activity declining 6 per cent on average in the four quarters subsequent to their implementation,” Toronto-Dominion Bank economist Diana Petramala told The Globe and Mail.

“The rules … could take a bigger bite out of activity next year given their breadth and the fact that they are being introduced at a time when many markets have become increasingly sensitive to any shocks.”

Capital Economics analyst (North America) Paul Ashworth warned that the effects of the new rules, which would mandate borrowers to qualify for the posted 5-year bank rate in mortgage insurance, would be far-reaching.

“The much more likely scenario is that the latest tightening of mortgage rules, announced last week, will trigger an even deeper slump in home sales, which will eventually lead to a sharp decline in prices,” Ashworth said.

“[It] could be very bad for the housing market. It is possible that lenders will simply decide to forego mortgage securitization and use their own balance sheets to continue offering ridiculously low interest rates and long amortization periods on what would then be uninsured mortgages,” he added.

Meanwhile, Emanuella Enenajor of Bank of America Merrill Lynch argued that the new measures miss the point as “aggressive lending” is not the problem right now, with earlier regulatory changes having taken care of less-than-optimal borrowers already.

“It’s still too early to tell how impactful these rules will be on housing activity, but for now, we see only a temporary, modest slowing of the housing sector for a few reasons,” Enenajor stated.

The revisions to mortgage rules announced last week would have better served the Canadian housing sector by being implemented in small stages, not as a sudden regulatory upheaval.

B.C. Real Estate Association chief economist Cameron Muir noted that the new measures introduced by Finance Minister Bill Morneau last week would—instead of cooling the markets as intended—drive off would-be buyers and slow down construction, CBC News reported.

“Introducing these measures as a single measure, a one-time shock to the economy, doesn’t seem to help affordability,” Muir cautioned.

The economist added that the mortgage market’s dynamism would be hit hard as potential buyers would be forced to stay in their current residences. Supply would thus be scarce by the time millennials have saved up enough to offset the larger down payments.

The prediction echoed that of Addenda Capital Inc. co-chief investment officer Jean-Francois Pepin, who warned last week that contrary to the expectations of lowered home prices as a result of the new rules, mortgage origination itself might be cooled down by the regulatory changes.

“If it slows down the housing market, it’s going to slow down the quantity of mortgages that will end up being on banks’ books, which means there’s a smaller pool that’s available to be securitized,” Pepin said in an interview.

The stricter rules—which would take effect on October 17—would mandate a more stringent “stress test” for first-time buyers who have CMHC-insured mortgages, evaluating their ability to repay under the big banks’ posted five-year rate.

The new federal rules governing Canadian mortgage will hit millennials’ home buying plans the hardest, according to the B.C. Real Estate Association (BCREA).

With the regulatory changes coming into effect on October 17, the BCREA warned that most young professionals and starting families will face greater challenges in getting their homes as they can lose fully 20 per cent of their purchasing power, HuffPost Business Canada reported.

BCREA outline a hypothetical scenario with a household that earns $80,000. Under the current rules, the family can purchase a home worth $505,000 home with a down payment of 5 per cent.

However, the stricter rules will force the household to settle for a residential property valued at $405,000 at most, as the regulatory changes mandate all insured mortgages with less than 20 per cent down payment to qualify at a higher rate bracket.

And while the new regulations might be able to reduce the economic risks that Canada faces in the event of a downturn or an interest rate hike, economist Brendon Ogmundson argued that the country’s real estate segment should brace itself for significant shockwaves (especially price pressures) in the near future.

“I think that the downside risk to tightening credit like this, at least in the next 12 to 18 months, is sharper, lower demand, potentially lower prices, as well as a decline in construction activity,” Ogmundson said.

Introduced by Finance Minister Bill Morneau last week, the tightened rules also included provisions for a new risk-sharing model that will compel banks to assume greater costs—which in turn can trickle down to consumers, according to market observers.

“[The new rules] would require mortgage lenders to manage a portion of loan losses on insured mortgages that default, rather than transferring virtually all the risk onto the taxpayer via the government guarantee for mortgage insurers,” Morneau told reporters on October 3.

It may be the most overlooked aspect of the Ministry of Finance’s most recent rule change announcement, but one economist who expects banks will soon shoulder more mortgage risk believes it will have a major impact on consumers.

“I believe that the ultimate proposal for lenders to take on the burden of more risk could … have a far reaching impact; this is something that CMHC proposed a number of months ago, almost a year ago, and it does appear that it’s going to happen,” Dr. Sherry Cooper, chief economist with Dominion Lending Centres, told MortgageBrokerNews.ca. “And it means the banks will probably have to cover 5-10% of the potential loss in their mortgage book.

“The risk of their mortgage book moves up, that means they have to hold more capital against their mortgage lending which makes the cost of capital more expensive and you better believe they’re going to try to pass that off to the consumer.”

In addition to its recent changes to mortgage insurance rules, the Department announced a consultation process that could lead to lender risk sharing. As it stands, banks don’t have any skin in the game.

“Today, the Government announced that it would launch a public consultation process this fall to seek information and feedback on how modifying the distribution of risk in the housing finance framework by introducing a modest level of lender risk sharing for government-backed insured mortgages could enhance the current system,” the Department of Finance said in its technical briefing of the changes. “Canada’s system of 100 per cent government-backed mortgage default insurance is unique compared to approaches in other countries.

“A lender risk sharing policy would aim to rebalance risk in the housing finance system so that lenders retain a meaningful, but manageable, level of exposure to mortgage default risk.”

The Globe and Mail reported Thursday that while banks have claimed publicly there is no need for risk sharing, bank executives have privately expressed support for the potential measure.

“Philosophically, people aren’t all that fussed,” one executive told the Globe.

A petition requesting the Department of Finance reconsider its recent mortgage rule changes has been launched.

It reads:

In light of the new mortgage rules in Canada that are scheduled to take affect October 17, 2016 the mortgage, real estate and insurance industry, as well as homeowners and citizens here believe that the rules imposed are excessive and:

1. Focused on minimizing/eliminating Monoline mortgage lenders that maintain healthy competition.

2. Eliminate re-financing options for homeowners

3. Will eliminate thousands of jobs in the real estate, mortgage and insurance sector

4. Reduce tax revenues at the municipal, provincial and federal level via lost wages, land transfer taxes and sales taxes from real estate industry affiliated businesses

5. Create a sharp decline in real estate values quickly depleting homeowners equity positions

The broker who shared the petition with MortgageBrokerNews.ca said the person responsible for it will remain anonymous for the time being.

Finance Minister Bill Morneau announced new housing policy measures aimed at protecting the nation’s housing industry.

Those preventative measures are; Standardizing lending criteria for high- and low-ratio mortgages, including a mortgage stress test, closing tax loopholes for capital gains exemptions on principal residence sales, and consulting with industry stakeholders to ensure risk is properly distributed. This may include lender risk sharing.

While the full impact of the rule changes has yet to be determined, many industry stakeholders have claimed they create a competitive disadvantage for the broker industry.

One requirement under the changes is that all insured mortgagors must qualify under the Bank of Canada’s benchmark five-year rate, which is currently 4.64%. According to Genworth Canada, 1/3 of its 2016 insured clients would not have had difficulty qualifying under these requirements.

Another major change was around low-ratio mortgage insurance eligibility requirements.

As of November 30, 2016, low-ratio mortgages from lenders that insure using portfolio insurance must meet the same criteria heretofore required of high-ratio insured mortgages.

Genworth published a great primer on what those requirements are:

A loan whose purpose includes the purchase of a property or subsequent renewal of such a loan;

A maximum amortization length of 25 years;

A maximum property purchase price below $1,000,000 at the time the loan is approved;

For variable-rate loans that allow fluctuations in the amortization period, loan payments that are recalculated at least once every five years to conform to the original amortization schedule;

A minimum credit score of 600 at the time the loan is approved;

A maximum Gross Debt Service ratio of 39 per cent and a maximum Total Debt Service ratio of 44 per cent at the time the loan is approved, calculated by applying the greater of the mortgage contract rate or the Bank of Canada conventional five-year fixed posted rate; and,

A property that will be owner-occupied.

As a result of these changes, some monoline lenders have cut some programs.

One major channel lender told MortgageBrokerNews.ca that it is holding off on making any changed before more information is known and the potential impact fully studied.

Yesterday, Ottawa unveiled major initiatives to slow housing activity both by potentially discouraging foreign home purchases and, more importantly, by making it more difficult for Canadians to get mortgages. As well, the Finance Minister is limiting the degree to which mortgage lenders can buy portfolio insurance on mortgages with downpayments of 20% or more. Ottawa has clearly taken out the big guns to slow housing activity, which is widely considered to be too strong in Vancouver and Toronto. Ironically, home sales have already slowed precipitously in Vancouver in recent months and the BC government introduced a new 15% land transfer tax on foreign purchases of homes effective August 6, the effects of which are yet to be fully determined.

The measures announced by Finance Minister Morneau are more far reaching than anything considered to date and could well have quite a significant impact. Not only are these initiatives intended to close loopholes for foreign investors, which might help to make housing more affordable for domestic purchasers, but they will actually make homeownership less attainable for the marginal borrower, which is often younger Canadian first-time home buyers.

Officials at the Department of Finance have been studying the housing market and have led a working group with municipalities and provinces, as well as federal agencies such as the Office of the Superintendent of Financial Institutions (OSFI) and Canada Mortgage and Housing Corporation (CMHC). This in-depth analysis has informed today’s announcement.

Measures Aimed At Foreign Homebuyers

•             The income tax system provides a significant income tax benefit to homeowners disposing of their principal residence, in the form of an exemption from capital gains taxation.

•             An individual who was not resident in Canada in the year the individual acquired a residence will not—on a disposition of the property after October 2, 2016—be able to claim the exemption for that year. This measure ensures that permanent non-residents are not eligible for the exemption on any part of a gain from the disposition of a residence.

•             The Canada Revenue Agency (CRA) will, for the first time, require all taxpayers to report the sale of a property for which the principal residence exemption is claimed.

Measures Affecting All Homebuyers

The Finance Department says in its press release that, “Protecting the long-term financial security of Canadians is a cornerstone of the Government of Canada’s efforts to help the middle class and those working hard to join it.” This is a “Nanny State” measure to protect people from themselves, as the Bank of Canada has long been concerned about the growing number of households with excessive debt-to-income ratios. It will make housing less attainable, at least in the short run. If it, therefore, substantially reduces housing demand, home prices could decline, ultimately improving affordability. This, of course, is not what the 70% of Canadian households that already own a home would like to see.

•             Broadened Mortgage Rate Stress Tests: To help ensure new homeowners can afford their mortgages even when interest rates begin to rise, mortgage insurance rules require in some cases that lenders “stress test” a borrower’s ability to make their mortgage payments at a higher interest rate. Currently, this requirement only applies to a subset of insured mortgages with variable interest rates (or fixed interest rates with terms less than five years). Effective October 17, 2016, this requirement will apply to all insured mortgages, including fixed-rate mortgages with terms of five years and more.

•             A buyer with less than 20% down will have to qualify at an interest rate the greater of their contract mortgage rate or the Bank of Canada’s conventional five-year fixed posted rate. The Bank of Canada’s posted rate is typically higher than the contract mortgage rate most buyers actually pay. As of September 28, 2016, the Bank of Canada posted rate was 4.64%, compared to roughly 2% or so on variable rate mortgages.

For borrowers to qualify for mortgage insurance, their debt-servicing ratios must be no higher than the maximum allowable levels when calculated using the greater of the contract rate and the Bank of Canada posted rate. Lenders and mortgage insurers assess two key debt-servicing ratios to determine if a homebuyer qualifies for an insured mortgage:

•             Gross Debt Service (GDS) ratio—the carrying costs of the home, including the mortgage payment and taxes and heating costs, relative to the homebuyer’s income;

•             Total Debt Service (TDS) ratio—the carrying costs of the home and all other debt payments relative to the homebuyer’s income.

To qualify for mortgage insurance, a homebuyer must have a GDS ratio no greater than 39% and a TDS ratio no greater than 44%. Qualifying for a mortgage by applying the typically higher Bank of Canada posted rate when calculating a borrower’s GDS and TDS ratios serves as a “stress test” for homebuyers, providing new homebuyers a buffer to be able to continue servicing their debts even in a higher interest rate environment, or if faced with a reduction in household income.

The announced measure will apply to new mortgage insurance applications received on October 17, 2016 or later.

•             Tighter Mortgage Insurance Rules

Lenders have the option to purchase mortgage insurance for homebuyers who make a down payment of at least 20% of the property purchase price, known as “low-ratio” insurance because the loan amounts are generally low in relation to the value of the home. There are two types of low-ratio mortgage insurance: transactional insurance on individual mortgages at the point of origination, typically paid for by the borrower, and portfolio (bulk pooled) insurance that is acquired after origination and typically paid for by the lender. The majority of low-ratio mortgage insurance is portfolio insurance.

Lender access to low-ratio insurance supports access to mortgage credit for some borrowers, but primarily supports lender access to mortgage funding through government-sponsored securitization programs.

Effective November 30, 2016, mortgage loans that lenders insure using portfolio insurance and other discretionary low loan-to-value ratio mortgage insurance must meet the eligibility criteria that previously only applied to high-ratio insured mortgages. New criteria for low-ratio mortgages to be insured will include the following requirements:

1.            A loan whose purpose includes the purchase of a property or subsequent renewal of such a loan;

2.            A maximum amortization length of 25 years;

3.            A maximum property purchase price below $1,000,000 at the time the loan is approved;

4.            For variable-rate loans that allow fluctuations in the amortization period, loan payments that are recalculated at least once every five years to conform to the original amortization schedule;

5.            A minimum credit score of 600 at the time the loan is approved;

6.            A maximum Gross Debt Service ratio of 39 per cent and a maximum Total Debt Service ratio of 44 per cent at the time the loan is approved, calculated by applying the greater of the mortgage contract rate or the Bank of Canada conventional five-year fixed posted rate; and,

7.            A property that will be owner-occupied.

These tighter mortgage insurance regulations will reduce the supply of mortgages and/or increase their cost to the borrower.

Consultation on Lender Risk Sharing

The Government announced that it would launch a public consultation process this fall to seek information and feedback on how modifying the distribution of risk in the housing finance framework by introducing a modest level of lender risk sharing for government-backed insured mortgages could enhance the current system.

Canada’s system of 100% government-backed mortgage default insurance is unique compared to approaches in other countries. A lender risk sharing policy would aim to rebalance risk in the housing finance system so that lenders retain a meaningful, but manageable, level of exposure to mortgage default risk.

This proposal by CMHC has been floated for some time and, needless to say, the Canadian Bankers’ Association, is against it. The measure would certainly increase the risk associated with funding mortgages and therefore likely increase the capital required to be set aside against this additional risk. Therefore, in essence, it increases the cost to the lenders to finance mortgages. The lenders will undoubtedly attempt to pass off this increased cost to the borrower or reduce its supply of credit. Right now, the cost of mortgage insurance is borne by the taxpayer.

Bottom Line: These are very meaningful initiatives to slow housing demand, making it more difficult for Canadians to borrow. Finance Minister Morneau has taken out the big guns. I have no doubt that the pace of mortgage lending will slow from what it would otherwise be as a result of these government actions. However, these actions do nothing to address the shortage of housing supply in Vancouver and Toronto.

Housing has been a very important pillar for the Canadian economy, especially at a time when oil price declines have decimated the oil sector and manufacturing continues to struggle. This is a case of being very careful what we wish for– I’m concerned that we might see more of a slowdown in housing than the government was counting on, which will certainly affect jobs and growth and reduce tax revenues at a time when budget deficits are mounting and fiscal stimulus has yet to do its job.

Finance Minister Bill Morneau announced three new housing measures aimed at protecting the nation’s housing industry.

Those preventative measures are;

Standardizing lending criteria for high- and low-ratio mortgages, including a mortgage stress test

Closing tax loopholes for capital gains exemptions on principal residence sales

Consulting with industry stakeholders to ensure risk is properly distributed. This may include lender risk sharing, Morneau told reporters

“Canadians have told us they are concerned about growing household debt and rapidly rising house prices in some of our biggest cities, particularly in markets like Toronto and Vancouver. These concerns have grown over many years, and there are no quick fixes,” Minister of Finance Bill Morneau said. “The federal government plays an important role in ensuring that housing markets are stable and function efficiently.

“My colleagues and I are committed to continuing to work with provinces and municipalities to address the concerns of middle class families, and to ensure Canada’s housing markets and financial system remain strong, stable and resilient well into the future.”

During a press conference to announce the changes, Morneau reiterated numerous times that he believes the housing market is stable.

Real Gross Domestic Product (GDP) in July was expected to continue its rebound from May’s steep, wildfire-driven decline, but the 0.5% monthly gain was better than many analysts had expected. The key driver was higher output in the mining, quarrying and oil and gas extraction sector. The rise in July followed a 0.6% increase in June, which had essentially offset an equivalent decline in May, which followed four back-to-back monthly declines. The non-conventional oil extraction industry grew 19%, as production returned to normal levels following maintenance shutdowns in April and the Fort McMurray wildfire and evacuation in May. Conventional oil and gas extraction rose 0.6%.

Mining excluding oil and gas extraction fell 3.1%, on the heels of a 2.4% gain in June. Mining of “other” non-metallic minerals (such as diamonds and potash) decreased 10% in July, mostly as a result of a diamond mine closure in the Northwest Territories for repairs following a fire in June. Metallic mineral mining also declined, while coal mining increased.

Support activities for mining and oil and gas extraction fell for the sixth month in a row in July, declining 6.9% because of lower activity in rigging and drilling services.

Manufacturing output rose 0.4% in July, as the gain in non-durable goods more than offset a decline in durable goods production. Leading the way was a sharp rise in output from chemical manufacturing, mostly petrochemicals, and pharmaceuticals and medicines. Food manufacturing rose 2.1%, as most industry groups recorded increases. There were declines in printing and related support activities, and beverage and tobacco manufacturing.

Durable goods manufacturing fell 1.4% in July, with most industry sub sectors posting decreases. Transportation equipment manufacturing was down 1.5%, primarily reflecting lower output by manufacturers of motor vehicles and parts, and aerospace products and parts. Computer and electronic products manufacturing rose for the second month in a row.

On the service sector side, finance and insurance grew 0.9% in July, its highest monthly growth since January 2016, owing to financial investment services and, to a lesser extent, banking services.

Retail trade increased, but not enough to offset the decline in June. There was increased activity at clothing and clothing accessories stores, building material and garden equipment supplies dealers, and general merchandise stores (which include department stores). Food and beverage stores recorded the largest decrease. Wholesale trade edged up only moderately. 

Construction Declined in July

Construction declined for the fourth consecutive month in July. Residential building, engineering and repair construction decreased, while non-residential building construction was essentially unchanged.

The real estate and rental and leasing sector increased 0.2% in July. The output of lessors of real estate rose 0.2%. Real estate agents and brokers posted their third consecutive monthly decline, down 1.0% in July as home resale activity decreased. This is further evidence of a slowdown in housing, confirmed by more timely data, particularly in Vancouver.

Tourism remained strong as accommodation and food services increased 1.4% in July–their strongest growth in four years. The number of travellers to Canada rose 2.3% in July, the highest monthly growth rate since June 2015. Tourism has been a major force boosting growth in British Columbia. A weak Canadian dollar has lured many Americans to Canada.

Utilities built on June’s large increase, as July was even hotter.

Bottom Line: These data confirm that we went into the third quarter on a stronger footing. Following the dismal GDP contraction of 1.6% (annual rate) last quarter, we expect Q3 growth to rebound to about 3.0% at an annual rate.