Chart of the Month – October 2019

How Vulnerable is Canada to a Catastrophic Mortgage Meltdown (Part 2 Government Debt)


Last month we reviewed the credit exposure that the Canadian banking system was exposed to in the Canadian mortgage market. We established that the market architecture was vastly different to that of the U.S. mortgage system and that in fact by virtue of compulsory mortgage insurance for the highest risk category of mortgages in Canada the Canadian banking system was well insulated from a catastrophic collapse in real estate values. In fact, the worst-case scenario which envisaged a 35% drop in real estate values in Canada would render the banks vulnerable for approximately 20% of their Tier 1 capital which would not bring them below their Tier 1 capital requirements.
The Canadian banking system is clearly secure but what of government finances given that they effectively guarantee the mortgage debt of Canada. To evaluate this one needs to look at the quality requirements for mortgages before they meet the approval standards of CMHC.
• Lender is an approved lender by CMHC
• The home is located in Canada
• For CMHC-insured mortgage loans, the maximum purchase price or as-improved property value must be below $1,000,000.
• Minimum down payment starting at 5%. (10% for mortgages above $500,000)
• Minimum down payment comes from borrowers own resources. However, a gift of a down payment from an immediate relative is acceptable for dwellings of 1 to 4 units.
• Total monthly housing costs, including Principal, Interest, property Taxes, Heating (P.I.T.H.), the annual site lease in the case of leasehold tenure and 50% of applicable condominium fees, shouldn’t represent more than 32% of gross household income (Gross Debt Service (GDS) ratio).
• Total debt load shouldn’t be more than 40% of gross household income
• CMHC ensures that building meet minimum construction standards
• CMHC requires that lenders provide evaluation criteria

As can be seen even in the real estate crisis of 2008, Canada’s delinquency rate did not rise above 1% whereas the US touched five times that level. The delinquency rate is not the default rate as many of these problem mortgages get saved either by restructuring or sale by the owner.

Historically the rate of default that has required CMHC to make payments to the lender has been extremely low at a rate below ½ of 1% of all insured mortgages.

Canada has a significantly lower Government Debt/GDP ratio that the USA at 84% versus 109% and is the second lowest in the G-7, only Germany has a lower ratio. Canadian Government debt is currently ~$700 billion. Were the worst case scenario of a real estate collapse of 35% to occur, the possible cost to the federal government would be approximately 20% of total insurance in force, which would amount to ~$100 billion and drive the nation debt to GDP level up by approximately 5% to 90% of GDP, still below the USA and most of G7 countries.

The result of this analysis suggests that the Canadian financial system is sound and that neither the banking system nor the government’s borrowing capability would be materially compromised by a real estate meltdown.