Canadian Shadow Banking Industry Growing Rapidly

RPT - INSIGHT-Ordinary Canadians turn bankers as shadow mortgage lending rises (Thomson Reuters)

By Andrea Hopkins
TORONTO, July 9 (Reuters) - Canada's housing boom is increasingly driving homebuyers to seek mortgages from private lenders, who demand rates that can be more than five times higher than those charged by the nation's banks.
Canadian house prices have risen 36 percent since June 2009, according to the Teranet-National Bank house price index. At the same time, Canadian banks have become more conservative and regulators are making it harder to lend, giving rise to an alternative market, including Canadians who refinance their own homes at low rates and then use the money to become mortgage lenders themselves.
Some analysts say a housing investment is increasingly risky because the pace of price increases has vastly outstripped wage growth, all amid a time of historically low interest rates and record debt levels. If and when interest rates rise, the concern is that consumers would have little ability to increase their payments, because they have so much debt.
"The risk arises if the unintended consequence of regulation is to push out the risk profile of the less regulated sector, and to encourage it to grow quickly at the same time," said Finn Poschmann, vice-president of policy analysis at the C.D. Howe Institute, a think-tank. "In dollar terms it is not a huge part of the economy (but) my concern is that we pay attention, because small problems sometimes get unexpectedly large, and quickly so."
Mortgage broker Lou Perrotta said that in terms of volume, 20 percent to 30 percent of the mortgages he puts together are now privately financed, typically because borrowers are declined for a bank loan for reasons like a low credit rating or unsteady income. That represents about C$4 million to C$5 million of the C$20 million ($15.69 million) of mortgage business he does annually, he said.
"Business is brisk, without question. (It has) probably tripled in the past three years," said Perrotta, president of Domus Financial Corp in Toronto, where house prices have increased by 55 percent in the last six years.
Perrotta acts as a matchmaker between individuals who have money to lend - and who are seeking higher rates of return than can be had in stocks or bonds - and borrowers who are willing to pay a higher mortgage rate to get into the market.
He also invests his own money, lending between C$25,000 and C$250,000 each to "five or six" borrowers a year who offer a good balance between risk and return.
"It's not for the faint of heart, and you need to understand the dynamics of real estate," Perrotta said.
One private lender, who asked not to be named because she is close to the real estate market and fears hurting her business, took out a C$400,000 mortgage on her paid-off home at 2.49 percent and then gave that money to a broker that lent it to a borrower at a higher rate, for a fee.
"Who the hell is going to give me 9 percent return?" said the lender, who said she has recourse to the borrower's assets if he defaults.
CIBC senior economist Benjamin Tal said the shadow lending market represents about 4 to 5 percent of Canada's overall mortgage market.
"This is something that is growing very fast, because many borrowers are not having access to banks because the banks are highly regulated," said Tal.
In Ontario, Canada's most populous province, private lending accounts for about 4 percent of new mortgage originations, or C$1.1 billion ($878.8 million), or 2 percent, of total mortgage lending by dollar value, according to Teranet.
While that's a fraction of the sub-prime lending that got the U.S. housing market into trouble seven years ago, analysts are concerned that the market is growing rapidly and may be concentrated in hot housing markets such as Toronto and Vancouver where a sudden downturn could take hold.

My view:

The overheated, highly leveraged Canadian housing market has been on the radar for several years.  Unlike the experience of the United States, housing prices continued their move upward despite the financial crisis of 2008.

Now that the government guarantee to the banks on low downpayment mortgages is more restrictive (CMHC rules tightened up), the shadow banking industry is filling the niche with high interest rate private loans.

Meanwhile, in Toronto and Vancouver, two extremely overpriced markets, the risk of a major price decline continues to build.

Private lenders are going to be hit hard quickly when the air escapes the Canadian housing balloon.  As the housing markets in Phoenix and Las Vegas prove, when prices start to drop, it can be breathtaking.  The impact on an already contracting Canadian economy will be dramatic.