Issue 2008 - 01 January, 2008 SUB-PRIME MARKETS How Canada Differs from the United States Sub-prime mortgages have been under intense scrutiny in recent months in the wake of a significant decline in performance of this asset class in the United States. However, there are important differences between Canadian and U.S. residential mortgage markets, including product, consumer behaviour, underwriting, regulation, and taxation. Below is a look at some of the more relevant factors affecting performance of Canadian residential mortgages compared with the United States. DEFINITION OF NON-CONVENTIONAL (SUB-PRIME) MORTGAGES Any uninsured loan originated outside of conventional mortgage lending criteria (often named ‘A’ or prime lending) as defined as non-conventional. Non-conventional mortgages can be further divided into Alt-A and sub-prime. Alt-A mortgages are usually provided to borrowers with high credit scores who wish to obtain a mortgage with a reduced level of documentation or a higher LTV than permissible under a conventional mortgage without mortgage insurance. Sub-prime mortgages are mortgage loans with varied degrees of LTV and documentation provided to borrowers with weaker or blemished credit histories. THE MORTGAGE MARKETS As of July 31 2007, the residential mortgage credit outstanding in Canada was $767 billion, according to the Bank of Canada. DBRS estimates that approximately 2-4% of this amount is for non-conventional mortgages, with the remaining 96-98% split evenly between insured mortgages and conventional mortgages. In comparison, the size of the residential mortgage market in the United States was USD $11.2 trillion as of July 31, 2007, according to The Federal Reserve Board and between 10% and 16% of this amount, approximating USD $1.1 trillion to USD $1.8 trillion, is considered to be sub-prime according various industry estimates. CONSUMER BEHAVIOURS Financial Leverage Canadians tend to be financially more conservative. At the end of 2005, the ratios for Canada and the United States of total household debt to total disposable income were 116% and 124%, respectively. According to Merrill Lynch, the ratio for the United States is estimated to have risen to 136% recently. Over the past four years, total American household debt rose by almost 70% as compared to the 40% increase seen in Canada. Another industry measure estimated that borrowing against home equity was approximately 8% of disposable income in the United States, compared with 4% in Canada. Credit Culture Canadians are more adverse to bankruptcy. Prior to the bankruptcy regulation reform in October 2005, it was relatively easy to file for personal bankruptcy and re-establish credit in the United States, without much credit stigma. This is evidenced by the higher U.S. bankruptcy rate (6.9 per thousand) for the year 2004 compared to 2.6 per thousand in Canada. Even after the reform, the U.S. bankruptcy rate was 2.1 per thousand for 2006 while Canada reported 1.7 per thousand. The risk-averse attitude of Canadians, combined with creditor friendly laws, help contribute to the high cure rate of 50% for defaulted mortgages in Canada where the lender is made whole without having to foreclose on the property. Mortgage Interest Deductibility There is no mortgage interest deductibility in Canada for personal residences without significant tax structuring whereas U.S. tax codes allow borrowers to deduct mortgage interest for tax purposes. This creates an incentive for U.S. borrowers to maximize their mortgage size and mortgage interest payments and reduces their desire to build and retain equity in the property, ultimately resulting in a higher loss severity upon foreclosure. Prepayment Due to the lack of interest deductibility, Canadian borrowers tend to pay down mortgages faster than contractually required, compared to U.S. borrowers for whom it is not tax efficient to do so. Absent home value appreciation, the lower propensity for principal prepayments creates little or no equity in the property to weather financial difficulties, especially as U.S. households have continuously sought to re-lever their homes. THE MORTGAGE PRODUCTS General Product Offerings Mortgage lenders in Canada have been more conservative in their product offerings than U.S. lenders who use a wide range of products to increase mortgage affordability. Examples such as Option ARM loans, which allow less than the full interest payments for a certain period or loans underwritten without any income or asset verification are not available in Canada. The use of second lien piggyback and interest only loans are also very limited in Canada with a maximum 107% LTV and a maximum 40-year amortization term versus 125% (though less available recently) and 50 years, respectively, in the United States. Floating-Rate Mortgages Approximately a quarter of mortgages in Canada are floating rate loans compared with one-third in the United States. In addition, floating rate mortgages in Canada are underwritten by having borrowers qualified based on their ability to meet the monthly contractual payment over the whole mortgage term (three to five years most commonly), while discounted teaser rates have been known to be used to qualify borrowers in the United States. Therefore, fewer borrowers in Canada are subject to payment shock if interest rates increase and/or payment adjustments occur when the teaser rate period expires, unlike their U.S. counterparts. Loan Performance Based on the data reported by the Canadian Bankers Association and the Mortgage Bankers Association in the United States, the default ratios (over 90 days in arrears) for prime mortgages have been similar and stable since 1998, in the range of 0.5% or less in Canada and 1% in the United States. Such similarity does not, however, exist for non-prime mortgages. The performance of Canadian non-prime (non-conventional) mortgages, based on the loans is far superior to U.S. non-prime loans. For example, in Canada, the default levels, including foreclosure and REO, (1.49% for all non-conventional mortgages and 1.92% for sub-prime mortgages at the end of Q2 2007) were very low compared to the 8.83% reported by the Mortgage Bankers Association as at Q1 2007 for the United States (note: Q2 2007 U.S. data is not yet available, however speculation runs as high as 20%). Such divergence of performance can be attributed to the factors discussed above which help mitigate potential default frequency and loss severity for Canadian loans. This difference has increased recently due to the US sub-prime deteriorating performance related to increasing interest rates at the time many loans with low teaser rates are to be reset and the substantial property price decline in certain U.S. regions. Next Issue: How the Sub-prime Mortgage Meltdown is Affecting Our Mortgage Market CURRENT RESIDENTIAL FIRST MORTGAGE RATES Term Our Best Rates Most Banks 6 month open 8.90% 8.90% 1 year open 9.50% 9.50% 6 month convertible 6.50% 7.05% 1 year closed 5.65% 7.35% 2 year closed 6.10% 7.40% 3 year closed 6.10% 7.40% 4 year closed 5.95% 7.34% 5 year closed 5.89% 7.39% 7 year closed 6.20% 7.70% 10 year closed 6.30% 8.05% Effective January 31, 2007 *Rates subject to change without notice at any time and subject to credit approval. Lender and/or broker fees may apply in certain circumstances. Your Mortgage Consultant will advise you accordingly. Our Below Prime Rate Mortgage TD SEES 'SIGNIFICANTLY SLOWER ECONOMIC GROWTH' AS CREDIT CRUNCH BITES Source: The Canadian Press December 13, 2007 TORONTO — Problems in credit markets are more serious and more persistent than initially thought, and “the dominant economic theme for 2008 will be significantly slower economic growth in the United States, Canada and around the globe,” TD Bank economists said Thursday. “Since our last forecast in September, we have become less sanguine about the near-term economic outlook,” stated deputy chief economist Craig Alexander. Tighter credit conditions will aggravate the weakness in American real estate markets, depressing consumer spending, the TD quarterly outlook says. The bank has cut its expectation of U.S. economic growth next year by more than half a percentage point to 1.8 per cent, and world economic growth is expected to slow by a full percentage point to 4.2 per cent. For Canada, the strong dollar, weaker foreign demand and a cooling in domestic activity are forecast to result in 2008 growth of 1.9 per cent. “However, economic conditions should improve in late 2008 and throughout 2009,” the bank added. It predicts the Canadian dollar will average 97 cents (U.S.) next year, trending down toward 94 cents. In the United States, “we still don't believe that a recession is the most likely scenario, but the risks have become acute,” commented Mr. Alexander. He added: “While there has been much talk about the ability of the global economy to decouple from a U.S. economic slowdown, this assumption is likely to be tested and debunked in the coming quarters.” 40 YEAR AMORTIZATIONS MAY WORK FOR YOU Our 40 year amortization products can open up new buying opportunities for many consumers who would not previously qualify. It also increases the purchasing power for homeowners who wish to upgrade to a larger home or refinance to use their existing equity for investment purposes. Give us a call to discuss how this option may work for you. DID YOU KNOW? We are located in the Cook Street Village upstairs from Starbuck's Coffee?   Contact Information: Beyer Mortgage Services Inc. 202 – 1075 Pendergast Street Victoria, BC V8V 0A1 250-592-9711 Main: 250-592-9711 Toll-free: 800-773-3711 Fax: 250-598-0638 Toll-free fax: 866-598-0638 Web: BeyerMortgage.com

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