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Posts from the ‘Home Capital Group (HCG)’ Category

The Canadian House Price Plateau (or cliff?)

I live in Calgary, Alberta.  The house prices here are high by most global standards.  The average sales price of a single family home in Calgary was $453,000 in December.

In Canada, Calgary is nothing special.  House prices in Canada are high.  I stumbled upon the following interesting research by the Demographia International Housing (DIH) that compared house prices across the globe.   Here is what they determined as being the unaffordable locales in Canada.

For those of you unfamiliar with Canada, Fredricton, Thunder Bay and Yellowknife do not represent a “hub” of Canadian population.  Vancouver, Victoria, Toronto and Montreal  do.

The above was taken from the DIH’s Affordability Survey (2012).   The methodology they use is to rank cities based on affordability is to use a ratio of the median home price in the city divided by the household disposable income.  The number gives a ratio, and a ratio of greater than 3 has traditionally been seen as creeping into the unaffordable category.

Whne I read through the report, my first question was, what exactly is household disposable income (HDI)?  From wikivest:

The amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.

In Canada, HDI is somewhere around $55-$65K depending on the source you use to calculate it:

While the DIH provided some interesting city by city numbers, I was able to dig up a Canada-wide number from a recent speech given by Mark Carney.  You have probably read sound bites from this speech before.  In particular the following shocking, over the top, end of the world type pronouncement about the Canadian housing market has been quoted widely:

Some excesses may exist in certain areas and market segments.

These central bankers are fear mongerers!

But not to worry, Carney also pointed out that overall the Canadian housing market is healthy:

Canada’s housing supply is relatively flexible, compared with other countries, and it appears to have grown at rates broadly consistent with underlying demand forces, the most important of which is the rate of household formation.

Of course, in the United States, in the time leading up to their housing collapse, Alan Greenspan and then Ben Bernanke said much the same thing.  One thing I have learned from reading all these books about the 2008 housing debacle in the US is that what a central banker says has more to do with the central bankers ideology is than the on the ground reality.

If you look at the data, you get a somewhat more worrying picture.  Below is canadian house prices to disposable income:

Overall the country is quickly approaching 4.5.  Using the DIH methodology, this would put the country as a whole in the “seriously unaffordable” category.

As for Calgary, with a ratio of 3.9, it is only “moderately unaffordable” (phew), though we are on the cusp of being “seriously unaffordable” (uh-oh). There is a really excellent analysis of how both house prices and household income have grown on the economic analyst website.  They posted the following comparison for Calgary in particular:

One more point about Calgary.   If you look at the median house price that is being used for Calgary by the DIH and others, you would be struck by the fact that it is $353,700 and not $393,000, which is median price reported by the CREB.  The reason for the discrepancy is that the $353,700 number includes  the “surrounding district” which means it includes Cochrane, Airdrie and some of the farming communities surrounding the city (Acme?).  If you include the metro Calgary area only, which is what the local real estate board does when they are reporting statistics (because they like to print higher numbers), it would put Calgary into the “seriously unaffordable” category.  I cannot find data on the area used to calculate the average household disposable income of the city, but I imagine it would be based on tax receipts and thus be restricted to the metro area.

Back to Canada as a whole, price to rents tells the same basic story.

Its either a heck of a bull market or a bubble.

As an aside I was amazed to learn that the price to disposable income in Vancouver is a rather bizarre 10.6.  And that is using a $678,000 median.  If you start using the average home price in Vancouver, the ratio is closer to 15.

Of course none of this has to end until interest rates show some sign of rising.  Right now our househols pays prime -0.9% on our mortgage.  That works out to about a 2% interest rate.  Its rather insane.  Even if we had a $500K mortgage (we don’t) it still be affordable.  Of course if that rate went to 6%, it would be a different story.  Some day that might happen.

Opportunities?

So why am I writing about this?  Well for one, I think its an interesting study.  The Canadian housing market has defied all other housing markets that have crashed and burned in the last few years.   It has also defied most all metrics of affordability.  For all the bears out there that say that the US housing collapse was inevitable it seems a reasonable question to ask: “then why not Canada too?”

I am of the mind that these forever rising prices, particularly Vancouver and Victoria and the inner city area of Toronto, are going to end badly some day.   Everywhere else in the world the 3:1 ratio holds but Canada is different?  The different argument is a big circular one.  Because the different argument inevitably comes down to the fact that Canadians are inherently prudent and would not expose themselves to large risks. Which apparently means that this attitude allows Canadians to take on large risks.  Anyways…

I also bring the topic up as a potential area for short candidates.    Who would be hurt by a price fall?  Particularly Vancouver.

Well first and most obvious is the Canadian banks.  Mortgage debt makes up around 42% of the loans on the balance sheets of Canadian banks.  This number has increased from 31% in 2002.

Another name that comes to mind is Home Capital Group.  The company is always being praised on BNN by some expert making a top pick.  The stock appears to trade relatively cheaply, at less than 10x earnings.  But the business of the company is to make loans to people that can’t qualify for CMHC loans.  I don’t know if the loans they make are “subprime loans” persay, they probably aren’t, but the company fills the exact same niche that the subprime borrowers in the US did.

I don’t know enough about the company to make any more observations than that right now. But it intrigues me.  The company is worth a closer inspection.

And I’m open to ideas.  What other companies could potentially be left with their pants down in the event of a material decline in Canadian house prices?   I think there is plenty of time to gather  more information about this trade.  There probably is not much to worry about until interest rates begin to rise.  And that might not happen for another couple of years.  Please contact me with any suggestions, either by email or in the comments.

It Helps to have Some Shorts

I’ve mentioned before how I can’t short in the RBC practice account that I post here. But I do own a number of shorts in my actual accounts.  On a day like we had yesterday, where everything is down, those shorts help a lot. That’s especially true when one of them implodes like it did last night.

I mentioned on my October 19th post that I had shorted Green Mountain Coffee Roasters (GMCR) after receiving a Google alert that they were the subject (victim?) of a David Einhorn presentation outlining the negative case for the company.

As an aside, I would really recommend having a google alert account set up.  Its easy to do, you just have to create a google account and list a number of key words for which you want emails sent to you when the googlebots find them.  One of my key words is Einhorn.  I was sent my first alert about his presentation about 10 minutes after the fact.  The stock had already dropped $7 but I sold it short at about $83.

I added to that short on Monday, rather presciently it appears, after reading Einhorns presentation in full over the weekend.  It anovervalued company, and the anecdotal accounting and inventory management schemes do sound rather fishy.  But even above all of that, we used to have various single serving coffee packet systems at work, including one for a while that used the Van Houtte brand, and they simply aren’t very good.  A number of us got headaches from drinking the coffee.  It gave you some weird buzz.  It just wasn’t normal coffee.  The machine we have at work now makes its single servings on the spot from real beans.  There is no comparison.

But enough about GMCR.  That boat has sailed, as it dropped some 30% last night in after hours after missing revenues.

Most of my shorts are put on as hedges against the current macro risks.  Therefore most of my shorts are bank stocks.   GMCR was one of two exceptions to this.   The other exception is Salesforce.com (CRM).  Unlike GMCR, which has already crated and the easy money made, I think there is plenty of downside left in Salesforce.com.  This article from Smart Money does a pretty good job of describing the bear case for the company.

One of the two bank shorts that I have accumulated is Bank of America.  Its my single largest short position, which is to say it is about the size of my average long position.  I shorted Bank of America for a number of reasons:

  1. Exposure to the US housing market.  As described in some detail in this testimony to the Senate by Laura Goodman, there is probably more risk of another wave of defaults as there is of an imminent recovery.  If the PrimeX index is any example, housing defaults will soon spill over into prime mortgages.
  2. Exposure to Europe.  In itself their exposure to Europe ($15B) is not going to send BoA to the edge.   But it doesn’t help.
  3. In need of capital.  The sale of preferred shares to Warren Buffett, the sale of the China Construction company stake, and recent overtures in SEC filings about raising capital all suggest more money is needed
  4. Unintelligible financial statements.
  5. They are, after all, king of the big bad banks.  This may mean they get bailed out if things get really bad, but it also means they remain near the center of the male storm that is Europe

UBS is my other short bank position.  To be honest, it wasn’t my first choice.  I have tried to short Deutche Bank and RBS in the past but can never get shares.  UBS seems to have problems whenever something blows up, and recent events just showed that the company does not have the best capital controls.

Finally, I have a small short that I just took in Home Capital Group (HCG.to).  They are a bit of a darling of the Canadian market, and do not trade expensively, at 10x earnings.  What they have against them is that they fund a lot of the non-convention loan demand in the Canadian mortgage market.  So they fund the loans that CMHC won’t insure or that need to meet special criteria to get them to insure.  I’ve put on and taken off the short in HCG a number of times, and this time will likely be no exception.  I like to have a short on them when the market is going into a liquidity crunch because the company is at the center of those liquidity markets.  I also like to have a short on them because its a free option on something eventually going wrong with the Canadian housing market.  While that has not happened yet, it seems to me likely to happen at some point.

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