Canadian price declines called the "Vancouver Manouevre" - Royal Bank declares Vancouver market in a correction

Well it certainly appears the concern about what is going to happen in the Real Estate market this Autumn is ramping up.

After an abysmal summer and all the negative press, the fall market usually see a resurgence in listings... but will there be buyers?

Judging by the comments of Bank Economists, it appears everyone is bracing for dismal times.

The Financial Post tells us that Canadian home prices are falling steadily.

Much of the decline in the national Canadian average is being blamed on Vancouver.

An economist at BMO Financial Group called it the “Vancouver Manouevre”. Our city's price drops have brought down the national average despite 19 of 26 cities experiencing year-over-year increases.

As we have mentioned here before, Vancouver's average sale price dropped more than 12% year over year and 20% since May 2012.

RBC economist Robert Hogue said:

"We still believe that Vancouver is probably the most stressed market right now because of extremely poor affordability. Plot the resale figures over the last year or so and you see a fairly significant decline in resales, so I think that this does the fit the definition of correction.”

Of course it does. When you have prices collapsing 20%, what other conclusion could you come to?

Naturally the British Columbia Real Estate Association (BCREA) disagrees.

(Surprise!)

BCREA chief economist Cameron Muir says:

“Typically to see a price correction you need to see a macroeconomic shock — recession, very high unemployment, for example — or you need to see interest rates go up very dramatically in a short period of time. Both of those we don’t see on the horizon.”

Cameron claims one-third of our market is first-time buyers and he insists there is no shortage of those 'first time buyers' to keep greasing the wheels of the property ladder:

“As long as we have first-time buyers that can get into the market to buy the homes from the people who are moving up, moving over, moving down, then the market should remain healthy.”

But if tighter mortgage regulations are making more difficult for potential first time buyers - and buyers are watching the market prices fall - when enter the market right now?

Watch for an unprecedented full out media campaign this fall promoting young first time buyers to do the 'smart' thing and get into the market.

In the absence of 'Hot Asian Money', what else will keep the ponzi going?

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Thurs Post #2: Now it's the Royal Bank warning of a correction!

Canada's largest bank, Royal Bank, has now joined the chorus of real estate doomsayers by coming out and proclaiming that the Vancouver housing market is vulnerable to `significant downturn'.

Robert Hogue, senior economist at RBC,  says there are fundamental factors supporting what he acknowledges is a "volatile" market.

In an RBC report Hogue wrote that prices are expected to decline for two key reasons: high prices and the dependence on wealthy foreign investors.

Hogue says these factors:

"... make the Vancouver-area market more vulnerable to a significant downturn than other Canadian markets if an unfavourable economic scenario or unforeseen shock (such as a change in China's policy regarding capital outflow) were to unfold. The constant flow of wealthy buyers coming from abroad is poorly documented, leaving the dynamics of the city's market rather opaque and opening up the possibility that critical market developments could be missed. For this reason, and the fact that the extremely poor affordability levels, quite frankly, make us uncomfortable, we urge caution."

Tsur Somerville, director at the University of B.C. Centre for Urban Economics and Real Estate at the Sauder School of Business, is often chided by bear bloggers for his pro-bull market analysis. But even Somerville is changing his tune.

"Were the inflow of capital from immigrants and investors to dry up or be reduced, that would put downward pressure on housing prices."

Somerville wouldn't predict how much prices would drop but did say;

"I have no idea and given what we don't know, you can't really model the market. It's very hard to figure out what's going on in the Vancouver because there are all kinds of don't knows. We don't know how many of those buyers are foreign buyers, you don't know how many are strict investment, you don't know how many are permanent residents, and you don't know how many are occupying their units."

How's that for turning on a dime? Sommerville out and out admits you really can't model the Vancouver market.

Perhaps he should stop allowing himself to be quoted as an expert on the subject, then. But I digress.

Hogue, who hedges his comments by hesitating to call for an out and out collapse, does note that the market is subject to "extreme unaffordability" and says that a typical Vancouver-area homebuyer would need to spend 92% of their income to carry the costs of a two-storey home, and as much as 45%of their income for a condo.

That this market will correct, and correct significantly, is gradually becoming obvious to anyone who doesn't let hope cloud observation.

Can you see clearly yet?

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A sign of things to come?

Real Estate watchers in the Village on the Edge of the Rainforest have seen high end properties in Vancouver shoot up over the past couple of years, but not everything has been making stunning gains.

And as all signs point to a looming market correction, there has been an interesting development.

The Penthouse at Shaw Tower in downtown (1077 West Cordova) sold this week.

Billed as Vancouver’s tallest waterfront tower, the Penthouse at Shaw Tower features panoramic unobstructed views of Burrard Inlet, the Five Sails of the Vancouver Convention Centre, Coal Harbour, Stanley Park, Lions Gate Bridge, English Bay, Downtown City Lights, and Mount Baker.  

The Penthouse suite occupies a full floor of the Shaw Tower and this has 4 bedrooms, a home office, climate controlled wine room, media room, and multiple large decks.  The interiors feature limestone flooring with radiant heat, custom wood mill work, chef’s kitchen, limestone gas fireplace, art feature walls, onyx, limestone, mill work closet systems and automation system, sunshades and blackout shades, security system, private hot tub, built in BBQ.  

The home comes with 4 parking stalls and private storage room.  The building has concierge service, gym, and private boardroom and home theatre.  Realtors bill it as a unique opportunity to own the most stunning penthouse in Vancouver.

The problem?

The property has languished on and off the market now for almost four years.

Back in May of 2011 it hit the market with an asking price of $19,800,000. The price was dropped to $15.5 million with not takers.

It finally sold this past week for $10.1 million.

The media reported the sale as a property that sold for 2/3rds of the asking price ($15.5 million down to $10.1 million) but when you take the asking price from May 2011 into account, it's almost a 50% drop.

Is this a portent of what's to come in Vancouver?

Hard to say.  A property is only worth what someone will pay for it and we have seen some real outlandish asking prices.  The real question is, what did the owner originally pay for it?

Is the $10.1 million sale price a gain or a loss? Did the owner dump the property because all signs are pointing downward?

We're not sure. But what does stand out is that the asking price had to be slashed in half to complete a sale.

Maybe Royal Bank (contrary to Phil Soper) was valid in preparing for a 25% real estate correction.

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Are Canadian Banks preparing for a housing collapse?

With each passing day of 2012, the real estate situation grows more and more intriguing.

Yesterday it was the stunning comments of Ozzie Jurock that grabbed out attention.

Today it is the actions of the Royal Bank of Canada.

During 2011 there was no mention from Canada's largest bank that potential disaster looms on the horizon.

Yet RBC CEO Gordon Nixon let slip at an investor conference in Toronto on Tuesday that Royal Bank of Canada is not only concerned, but has taken the unusual step of conducting stress tests on its books to see how Royal would withstand a decline in housing prices by as much as 25%.

Nixon is quick to point out that the bank doesn’t figure the situation will become that dire, but he is concerned enough that he has investigated whether RBC's lending operations could withstand such a large hit if one were to occur, particularly in the Vancouver and Toronto condominium markets.

The bank’s exposure to the Canadian condo development market is about $2-billion, Mr. Nixon said.

No matter how you spin it, this is a stunning development.

Yesterday perennial R/E cheerleader Ozzie Jurock astonished local observers by telling followers to ignore that fact that Vancouver prices are the same this December over last December and to focus on the fact that:

• the December average price of $ 691,000 is a whopping $141,000 or a full 17% lower than the May 2011 average price (which clocked in at $834,000).
• that overall sales decreased 13% over last December and were a "WHOPPING" 34.1% lower than in December 2009. 
• and that sales of detached properties decreased 18.1% from the sales recorded in December 2010, and were a "WHOPPING" 30.2% lower than in December 2009.

Over on the blog, Vancouver Condo Info, the conversation focused on the dramatic numbers coming out in local real estate.

Noting that it’s normal this time of year for listing to outnumber buyers as people who haven’t managed to sell relist their property, the observers at VCI are taken aback at just how significant the ratios are.

Leading the pack were the numbers for the westside of Vancouver with 96 new listings, 10 price changes and an astonishingly paltry 5 sales.

The author of the post says, "Yes, that’s right. 96 new listings on the west side of Vancouver on one day and only 5 sales. Any idea whats going on here? Were there so many listings that all the sales didn’t get entered, or did we really just have crazy sales/ list ratio day?"

As we noted yesterday, Ozzie Jurock may have provided the answer when he suggests to all who will listen that, "if you are a seller - list now! If you are a buyer, take your time, the market will not run away from you."

And with Canada's largest bank testing the waters to see how they would withstand a housing collapse of up to 25%, one can only imagine that those list/sell ratios will intensify dramatically.

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Are alarm bells sounding in the financial community about CIBC and Royal Bank?

Back in August, the website Zero Hedge sparked a debate about the soundness of Canadian banks.

The issues raised about Tangible Common Equity (TCE) were quickly dismissed by Canadian authorities, but the issue has been raised again with a slight twist.

In a post tonight, Zero Hedge strikes again zeroing in on something called Re-hypothecation which lies at the heart of the whole MF Global scandal.

In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.

In the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated.

By 2007, re-hypothecation had grown so large that it accounted for half of the activity of the shadow banking system.

Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as “churn”), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation.

In its quarterly report, MF Global disclosed that by June 2011 it had repledged (re-hypothecated) $70 million, including securities received under resale agreements.

The off-balance sheet treatment means that the amount of leverage (gearing) and systemic risk created in the system by re-hypothecation is staggering.

Re-hypothecation transactions are off-balance sheet and are therefore unrestricted by balance sheet controls. Whereas on balance sheet transactions necessitate only appearing as an asset/liability on one bank’s balance sheet and not another, off-balance sheet transactions can, and frequently do, appear on multiple banks’ financial statements.

What this creates is chains of counterparty risk, where multiple re-hypothecation borrowers use the same collateral over and over again.

Essentially, it is a chain of debt obligations that is only as strong as its weakest link.

With collateral being re-hypothecated to a factor of four (according to IMF estimates), the actual capital backing banks re-hypothecation transactions may be as little as 25%. This churning of collateral means that re-hypothecation transactions have been creating enormous amounts of liquidity, much of which has no real asset backing.

So what does all this have to do with CIBC and Royal Bank?

With weak collateral rules and a level of leverage that would make Archimedes tremble, firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.

Engaging in hyper-hypothecation have been

• Goldman Sachs ($28.17 billion re-hypothecated in 2011),
• Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets),
• Royal Bank of Canada (re-pledged $53.8 billion of $126.7 billion available for re-pledging),
• Oppenheimer Holdings ($15.3 million),
• Credit Suisse (CHF 332 billion),
• Knight Capital Group ($1.17 billion),
• Interactive Brokers ($14.5 billion),
• Wells Fargo ($19.6 billion),
• JP Morgan($546.2 billion),
• and Morgan Stanley ($410 billion).

That's right, CIBC and Royal Bank have over $125 Billion of collateral backing up its derivatives book which is actually client collateral!!!

When the crunch came for MF Global, their clients collateral was seized and is now gone. It is being suggested that MF Global's bankruptcy has already set off a chain of events which not even all the world's central banks can halt.

Back in August, Canadian banks defended themselves against the concerns of TCE. And anyone looking through the balance sheet of Canadian banks could turn up no alert signals.

Was it because hundreds of billions of dollars worth of debt exposure was off the books?

Reuters is reporting on the MF Global Re-hypothecation scan here. It explains the whole issue very well. From the article:

A legal loophole in international brokerage regulations means that few, if any, clients of MF Global are likely to get their money back. Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients.

After reading all this, do you feel safe with your money at CIBC or Royal Bank?

Look for lots of interest in Canada to be generated by this latest Zero Hedge post.

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Time Mortgage Bomb

According to CMHC, 30% of all Canadian mortgages are now variable rate mortgages, up from 3% in 1998. And fixed 5 year terms account for almost 70% of the mortgage market.

So why don't many Canadians take out a 25 year mortgage? They exist. Royal Bank even lists them on their residential mortgage rate page.

It's all about 'affordability', the real estate industry's favorite catchword.

A 7.85% rate on a $555,000 amortized over 35 years results in a monthly payment of $4,420.

You can currently get a 1 year variable rate for 2.35%, which translates into a monthly payment of $2,495.

That's almost $2,000 a month less in payments.

So who in their right mind would opt for a 25 year mortgage? Even a five year rate from Royal (4.19%) will set you back $3,070 a month.

And for all those suckers buyers rushing into the market right now because homes are 'affordable' (i.e. low interest rates), saving $500 a month makes all the difference in the world.

And besides, rates have been relatively low for the past 8 years. They will stay like this for a long time.

And therein lies the looming disaster.

$500 makes all the difference in the world. As rates start to go up, many variable rate mortgage holders won't lock into 10 or 25 year rates. It's too much of a jump.

They won't even lock into a five year rate.

They have rationalized 'affordability' to make the purchase. When rates jump up 2%, the one year variable rate will cost them $500 more. To lock into a 5 year rate will cost them another $500 over that (at least).

The same argument that keeps them in a one year rate, will keep them in that rate then.

Even if some do lock in to a longer term rate, it will be a five year rate - at best.

But the fuse on the Lower Mainland mortgage time bomb will have been lit. And when it explodes this is what it will look like.

As the San Francisco Chronicle reports, the Bay area is sitting on a $30 Billion dollar time bomb of homes purchased with loans known as option ARMs, short for adjustable rate mortgages (Alt-A).

From 2004 to 2008, "one in five people who took out a mortgage loan (for both purchases and refinancing) in the San Francisco metropolitan region got an option ARM," said Bob Visini, senior director of marketing in San Francisco at First American CoreLogic, a mortgage research firm.

With these mortgages, the interest rate will reset after 5 years to a dramatically higher rate. Buyers took them because Alt-A and Option ARM allowed them to enjoy an 'affordable' low interest rate for the first five years. At the end of five years (during the boom years), buyers were advised they could re-negotiate a new mortgage (with a new low five year rate) especially since the value of their home will have risen.

Problem is... housing prices in San Francisco have evaporated... and so has the chance to obtain a new mortgage. It means thousands of buyers in the Bay area are going to be forced to watch their mortgages reset at dramatically higher interest rates as their five year terms expire.

There are over 54,000 option ARMs issued in greater San Francisco with a value of about $30.9 billion.

"In markets where home prices were going up rapidly, more and more borrowers needed a product like this to afford something," said Alla Sirotic, senior director at Fitch Ratings. The loans became a tool for regular people to "stretch" to buy homes that were beyond their means.

Can you see the parallel to what may happend in Canada when mortgage rates start rising?

The sad thing is, if you can, you are in the minority.

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