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                               Could the Canadian Market Follow the Same
                               Course as the U.S. Market?
                               Provided by Gareth Watson, CFA, ScotiaMcLeod

                               Many of you may have heard that Merrill Lynch issued a report in which they
                               believe the Canadian Housing Market could follow the same course as the U.S.
                               Housing Market. I contacted Derek Holt of Scotia Economics to get his point of
                               view on this subject and he provided me with the following response:
Thomas O’Brien
                               “Bottom line is that I agree there are downsides to Canadian housing via lower
Mortgage Development           construction and resale volumes, and lower prices. But mortgage market
Manager                        comparisons are way off base. For now, some key points:

Ottawa District                     Canadian subprime is small (5-6% of outstanding mortgages) whereas
                                     U.S. share was about 3 times that. As a share of originations, 20-25% of
613-866-2624                         new mortgages in the U.S. were subprime over the 2004-06 period.
                                    Canada's subprime is more like U.S. near-prime, or Alt-A. More
                                    Debt-to-income comparisons are meaningless since it compares debt
                                     financed over decades to a single year's income. Debt-to-assets is a
                                     much better leverage measure and Canada is far below the U.S.
                                    Our mortgage equity withdrawal market isn’t like the U.S. We've seen
                                     secured home equity lines of credit (Helocs) grow in Canada as a way of
                                     withdrawing equity, but nothing like the U.S. withdrawals picture.
                                    Funding model is different: less securitization in Canada, more retail
                                     funding. Plus, not funded by short-term lines from other financial
                                     institutions as in the U.S.
                                    MBSs were not placed in off-B/S SIV and CDO structures as in US. So
                                     not the same heavily leveraged investor risks. This is perhaps the most
                                     important point.
                                    The nature of the products has been very different. Long-amortization in
                                     Canada is nothing like Ninja mortgages. Relatively speaking, mortgage
                                     innovation was needed in Canada, but has been relatively more
                                    ARMs resets in the U.S. usually occur suddenly. Variable rate mortgages
                                     in Canada get constantly repriced so people aren't caught off-guard years
                                     later. Plus some variable rate products adjust the principal, not the
                                     payment in Canada.
                                    Investor mortgages in Canada are about 2-3% of all outstanding
                                     mortgages, versus 10-11% in US and UK.
                                    Another point is that the reason why loan growth as a share of income
                                     soared in Canada earlier this decade is that our housing downturn was
                                     much more severe in the early 1990s, and we took longer to see a
                                     material housing recovery than they took in the U.S. So pent-up demand
                                     was being unleashed in Canada. If, instead, we consider the whole cycle,
                                     then the variable that matters is the end-point on leverage, which is far
                                     lower in Canada today than in the U.S.
                                  There are many points to make, but the bottom line makes for very different
                                  mortgage market comparisons.”

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