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Theodor Tonca
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Mere mensch, investor (Chairman & CEO of Graham Theodor & Co. Ltd.), and an all around nice guy.

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  • The Next Short 0 comments
    Sep 29, 2010 4:39 PM

    To borrow the title from Michael Lewis’s best selling book The Big Short, this article is about another impending residential real estate crash, although this one is forthcoming  from North of the border.

    For anyone with the belief that Canada’s financial regulations are superior or more prudent than the United States, I strongly encourage you to read this article and others like it.

    Canadian Housing Market

    While the overall size of the residential housing market is only $13.1 Mil. households the total value of all outstanding residential mortgage loans in Canada is estimated to be CDN $940 Billion* (USD $1.1 Tril.)*

    Of these total loans outstanding approx. CDN $300 Bil. Are outstanding mortgage backed securities created by the Canadian Mortgage Housing Corporation (CMHC) which means that those MBS’s are residential loans made by Canadian banks with an LTV of 95% and insured and subsequently securitized by the CMHC.

    These loans which contain an LTV of 95% are typically made by first time home buyers, which may or may not pose a greater systemic risk than home buyers which put an average of 15% or more down. But as we just recently found out in the US the former case is usually correct.

    Another largely significant note is that because the CMHC is a crown corporation owned by the Canadian government, the CMHC insured loans which were securitized are fully guaranteed by the Canadian government and not MBS investors as was the case with loans securitized in the US. Therefore, it is ultimately Canadian taxpayers which will foot the bill in the case of defaults of these securities.

    As evidenced by recent statistics the Canadian housing market which is currently well above median price levels is starting to downtrend in major metropolitan markets such as Toronto, Vancouver and Calgary.

    According to the CMHC housing starts in Canada have declined for a fourth consecutive month in August, a move which began in May. There was also a dip in new home prices in May (-0.1) for the first time in over a year.

    Canadian Housing Starts & Prices

    All this in a rising interest rate environment as evidenced by the Bank of Canada’s past two consecutive quarter of a percentage point hikes in 2010.

    Bank of Canada Overnight Interest Rate

    While a significant downturn in the residential housing market is not expected under current conditions, the accelerating condition of deterioration in the US economy (which I fully anticipate) will serve as a further catalyst as Canada has traditionally been on an economic lag with its largest trading partner.

    The Short

    Since (unfortunately) the CHMC is not shortable itself as its counterparts in the US, Fannie Mae and Freddie Mac are. Nor are the MBS’s guaranteed by Canadian taxpayers on banks books, short selling Canadian financial institutions is not relevant either.

    In this case, we must turn to the various TSX listed Canadian REIT’s such as Northern Property REIT (TSX: NPR.U) and Boardwalk REIT (TSX: BEI.U) as these REIT’s are most exposed to multi-family residential properties in Canada.

    While market timing in the strictest sense is not my particular area of expertise, I would nonetheless advise a short position not to be undertaken until perhaps the end of the first quarter or two of 2011 as I believe, as is widely expected that the US Federal Reserve will announce further quantitative easing either at their Nov. 2-3 or Dec. FOMC meeting.

    In the short term this will almost certainly cause a further uptrend in all securities (precious metals, stocks, bonds) not only in the US market, but also in securities listed on the TSX.  After this initial euphoria by market participants, we will undoubtedly begin seeing a reversion to the mean in the price of most classes of securities, including those most intrinsically overvalued at the moment which I solemnly believe to be equities (including the fore mentioned Canadian REIT’s) as well as US bonds, to say nothing of the inflated US dollar.

    * Statistics Canada

    Sources: CCAMP: Annual State of the Residential Mortgage Market in Canada, Nov. 2009 | Globe & Mail: How Canada’s Housing Market continues to cool | Statistics Canada | Bank of Canada

    Disclosure: No positions

    Disclosure: No positions
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