November 14, 2016

CANADIAN BANKS
THE GREAT CANADIAN HOUSING &
REAL ESTATE CONFERENCE 2016 ROUND-UP
Asking the Difficult Questions

Financial Services

Mike Rizvanovic
mrizvanovic@veritascorp.com
Sherry Ye
sye@veritascorp.com

Veritas Investment Research Corporation owns the copyright in this report. This report may not be reproduced in whole or in part without Veritas’ express prior
written consent. Any such breach of this copyright is contrary to ss. 27(1), 34, 35 and 42 of the Copyright Act, R.S.C. 1985, c. C-42 and will be liable for
damages.
Canadian Banks – Real Estate Conference Round-up November 14, 2016

ASKING THE DIFFICULT QUESTIONS

We would like to thank everyone who was able to join us for Veritas’ fifth annual Great Canadian Housing &
Real Estate Conference at the Albany Club in Toronto on November 3rd, 2016. We had a capacity crowd of 125
invited guests who represented pension funds, asset managers, hedge funds, foundations, wealth managers,
and private family offices from across North America. The goal of the event is to provide critical insights from
independent experts that help inform our clients’ investment processes.

Our conference featured nine presentations that covered a wide range of topics related to Canadian housing
and the broader real estate market. Our four-member investment roundtable shared their investment strategies
in a boom or bust scenario. We have also included the findings from our Condo Mystery Shop that took place in
the weeks preceding the conference.

Based on the comments and research presented, the optimistic case is for residential real estate transaction
volumes to slow and prices to flat line. The pessimistic case, calls for a significant crash with significant negative
wide-spread economic repercussions. While the range of opinions is wide, a number of issues are relatively
certain including: 1) the current pace of residential house price appreciation is not sustainable; 2) the recent rise
in Canadian bond yields may put pressure on mortgage rates; and 3) even a flat-lining in home prices would
negatively impact the Canadian banks.

Below, we present a summary of noteworthy points from each presenter:

1. Tamsin McMahon – Real Estate Reporter, The Globe & Mail

A Review of the Last Twelve Months

 Costs to mortgage lenders and insurers are rising. This will likely translate into higher mortgage rates
and insurance premiums though it isn't clear exactly how deeply consumers will be affected by this.
The mortgage industry is moving toward a more risk-based system of housing finance, where
consumers may face different mortgage rates and terms depending on their personal credit profile
and even where they live.

 Changes to portfolio insurance and mortgage-backed securities are part of an attempt by Ottawa to
encourage more private-market mortgage financing. Housing finance is now heavily dependent on
government-backed mortgage insurance in Canada. Rule changes may force some non-bank
lenders in particular to look for alternative sources of funding. Genworth has said it is exploring the
market's appetite for a mortgage insurance product that is not backed by a government guarantee,
including the potential for non-CMHC mortgage-backed securities.

 There is now a higher likelihood of slower home sales and even flat or falling prices in the housing
market over the next year, although past moves to restrict lending and speculation in the housing
market have proved to be temporary.

2. David Ley – Professor of Geography, University of British Columbia

Housing Bubbles: Global & Canadian Experiences

 The free flow of capital and people is critical to sustaining demand for real estate: A global housing
market has been created in gateway cities (e.g. London, New York, Sydney, and Vancouver), which
are nodes of global flows of capital, trade and labour where residential real estate has become a
commodity as well as a use. Through time and as a result, the home prices of these cities have
uncoupled from the national housing market in their respective countries, making them especially
susceptible to high prices and price volatility including bubbles.

 Vancouver and surrounding area is in bubble territory: Foreign investment has driven the top end of
the market. Mainland China has emerged as a leading exporter of capital. Global investment from
China is expected to rise from $5 trillion in 2012 to $18 trillion by 2020. Among the wealthy Mainlanders,
40-60% are considering or planning emigration. According to surveys, the most preferred locations to
invest and to move are the Pacific Coast gateway cities of North America, including Los Angeles, San
Francisco, and Vancouver.

Mike Rizvanovic|mrizvanovic@veritascorp.com | 416-866-8783 1

Canadian Banks – Real Estate Conference Round-up November 14, 2016

 Watching the high end of the market is key: The Economist magazine, while supportive of
globalization, notes in its October 2016 supplement that of the three global flows, trade, labour and
capital, “liberalizing capital flows can sometimes do more harm than good”, and concludes that
“limits on capital flows other than FDI (foreign direct investment) seem like a good idea”. Vancouver’s
15% tax on foreign home purchase in July 2016 is a blunt version of such a tax, and has had an
immediate effect in cooling especially the high end of the market. There is evidence that some
Chinese investment is being displaced to Seattle.

3. Gregory Klump – Chief Economist, Canadian Real Estate Association

Canadian Housing Market Bubble? Assessing the Evidence

 Home prices will sag but not crash since home prices tend to be sticky downward and there are low
levels of house supply on the market (e.g. about one month of inventory in the GTA, and about three
months of inventory in the Lower Mainland in BC after the recent slowdown in sales activities).

 Sales volume will soften going forward.

 Align your investments: More money will be made taking an investment position aligned with the view
of stagnating home prices and lower sales volumes.

4. Porter Collins – Portfolio Manager, Seawolf Capital (former Senior Analyst at FrontPoint Partners)
“The Big Short” Experience

 Possible triggers that will burst the bubble include:

 An economic recession – regional Canada, Canadian, or U.S.;
 Higher borrowing rates;
 House price appreciate flattens out;
 Credit tightens;
 15% tax on foreigners weighs on demand;
 A change in risk weighting for banks; and
 Procyclicality of loan loss reserving.

 Comparisons between the U.S. in 2006 and Canada today abound:

 Differences include (1) Canada does not have the same securitization machine as the U.S. did; (2)
Canada does not have the huge rate reset problem; (3) Canadian regulators have a better
handle on the challenges; (4) U.S. banks were generally better capitalized; and (5) the Canadian
government will bear a bigger portion of the damage in the event of a Canadian housing crash.
 Similarities include (1) construction activity gone wild; (2) fevered pitch of real estate activity; (3)
home price appreciation at an unsustainable pace; (4) home price appreciation is completely
divorced from reality (e.g. income growth); (5) underwriting fraud; (6) deteriorating underwriting
standards; and (7) a massive increase in consumer leverage.

 Funding is crucial. Those lenders that do not have access to funding in a stress event will be the first to
go.

5. Alex Thomson – Senior Vice President, Canada ICI

The State of Canadian Commercial Real Estate

 Office Buildings:
 B-class owners will face a major crisis as a result of higher expectations of employees for amenities
and the difficulties in retrofitting these spaces to meet emerging working trends such as, reduced
office space. These owners will need to be active and creative if their buildings are to stay
relevant.
 Toronto downtown will continue to experience major new supply in the coming years, adding to
the pressure on older buildings.
 Office space requirements are set to decline by approximately 25% from 2000-levels as employers
choose dense office layouts and less space per employee.

Mike Rizvanovic|mrizvanovic@veritascorp.com | 416-866-8783 2

Canadian Banks – Real Estate Conference Round-up November 14, 2016

 Industrial Buildings:
 Industrial distribution centres face transformation to provide the automated, data-connected
warehousing required by the modern supply chain.
 Older industrial product close to urban centres will be more relevant as retail-oriented logistics firms
try to accommodate same day delivery to consumers.

 Retail Centres:
 Online retail is still only a small percentage of all sales in Canada, but is having an impact.
 The mid-market retailers and the malls they occupy will suffer the most due to changing consumer
preferences.
 Those malls that build a brand / image with consumers, combining leisure and recreation
opportunities with shopping, will be successful.

6. Hilliard Macbeth – Author & Portfolio Manager, Richardson GMP

The Case for a Bubble Scenario in Canada

 The inevitable correction in the Canadian housing market will be worse than a soft landing. A study of
28 bubbles in the history of the world showed that none of the bubbles escaped a hard landing and
that every bubble corrected completely back to trend or beyond. The Canadian economy is heavily
reliant on the real estate sector and Canadians are increasing their exposure to real estate (e.g. in
comparison to the Baby Boomers, Canada’s Generation X has disproportionately large amounts of
household assets invested in their principal residence and other real estate).

 Canada is experiencing a debt bubble with private sector debt at >200% of GDP. CMHC’s mortgage
insurance and the Bank of Canada’s low rates are the main drivers for the significant expansion in
debt levels.

 Canadian banks will suffer from a real estate crash: Given the significant outperformance of
Canadian banks relative to their European and U.S. counterparts following the Financial Crisis, the high
price to book value multiples the banks are trading at, and the lower level of CET 1 capital that
Canadian banks hold.

7. Joseph Mancinelli – Vice President, Laborer’s International Union of North America

Housing Construction: Is There Sufficient Labour Capacity?

 There is a shortage of skilled workers in Ontario: That shortage is expected to continue. Over the next
10 years, 86,500 construction workers are expected to retire in Ontario. The province’s labour force
needs to grow by 23,400 to meet the demands created by increased construction activity. Altogether,
this means that Ontario needs to attract 109,900 new construction workers over the next 10 years.

 Residential construction could face labour shortage: Of all retirees covered by LiUNA’s pension plan
from March 2014 to October 2016, more than 21% worked in the residential construction industry.

 Immigration only helps modestly: The type of immigrant Canada is accepting generally does not
favour skilled labour jobs.

 Outreach can grow the labour force: LiUNA is fostering relationships with First Nations and undertaking
targeted marketing programs at young people to attract individuals to skilled labour training
programs.

8. Harvey Strosberg / Jay Strosberg – Senior Partner / Partner, Sutts, Strosberg LLP
The Legal Perspective

 Class actions worth noting: There have been a number of class action lawsuits from owners of new
condo buildings in Toronto over the past years.

 Reasons for the class action cases: These include shoddy construction (e.g. poorly-welded water joints
leading to flooding of condo units) and misrepresentation at the time of sale (e.g. in one case the

Mike Rizvanovic|mrizvanovic@veritascorp.com | 416-866-8783 3

Canadian Banks – Real Estate Conference Round-up November 14, 2016

builder implied that the condominium would have direct access to the subway line; a promise that
was not kept).

 More similar cases can be expected: This primarily arises as construction is done in haste and buyers
are not paying careful attention to the products they are buying.

9. Mike Rizvanovic – Research Analyst, Veritas Investment Research

The Impact on Canadian Banks

 Likelihood of a near term slowdown in Canadian lending volume: Aside from the credit risk related to a
slowing housing market, loan growth for the large Canadian banks could slow materially in the next 2-
3 years. Mortgage origination dollar volume is impacted by both price and sales activity, the latter of
which can decline materially as soon as prices start to flat line. We have already seen this occur in
Calgary, and more recently in Vancouver.

 Condo investment returns are risky at best: With investors accounting for a large portion of condo
buyers (the majority in the case of Toronto), our closer examination of the investment return profile
shows that further price appreciation is required in order to secure a reasonable return. Condo
builders are becoming increasingly creative with incentives for buyers; in one case offering to cover
two thirds of a buyer’s 15% deposit with an interest-free, payment-free loan.

 Watch the marginal borrowers: Recent changes by regulators will be impactful over time as more and
more marginal borrowers are priced out of the market, gradually shrinking the pool of buyers.

We visited numerous condo pre-sale centers around the GTA, and had meetings with a mortgage syndication
group and a condo marketing group. Our key findings are:

1. Buying into the market remains relatively easy:

The sales process is the same; you don't need a mortgage pre-approval to buy a pre-construction
property. Deposit requirements are generally 20%, although incentives are offered in many cases.
Tightening mortgage standards in the industry could potentially lead to some buyers not being able to
close on their purchase, which in many cases in several years out.

2. Sales activity seems more robust in GTA:

Based on our discussions with sales agents at various sites, foreign investment has picked up in the GTA as
there appears to be some spillover effects from Vancouver following the recently-announced 15% tax on
foreign buyers. We understand that roughly 70% of pre-construction units (in the GTA) are sold to investors,
approximately 30% of which are foreigners.

3. Location is key to pricing and incentives:

Sales incentives are greatest for properties destined further from the public subway system and
downtown areas. Some of the more popular incentives include: rental guarantees, deposit matching
programs, free maintenance fees, a discounted deposit schedule (5% to 10% versus 20%). In general,
many condos are being marketed as investments.

4. More complex investment structures are being created that allow individuals to invest in real estate:
We visited with a regulated mortgage syndication group that markets a +20% return for mortgage
investments secured by a condo development’s land and soft costs. Payout occurs when projects are
closed – usually between 3 and 6 years. We also visited an unregulated marketing group that sells condos
ahead of their release to the public to investors who are considered “insiders” and designs turn-key
investment structures into student residence condos. Returns of >30% are featured. Products are being
marketed to homeowners who are thought to “understand real-estate”.

We would like to thank our speakers and investment roundtable participants, Porter Collins (Seawolf Capital),
Tom Dicker (Dynamic Funds), Gregory Guichon (Barometer Capital), and Michael Simpson (Sentry Investments),
for their insights on Canadian housing and real estate. We would also like to thank our clients, near and far, for
attending this event. For those that were not able to attend the event, we will be arranging follow-up meetings
to share our findings.

Mike Rizvanovic|mrizvanovic@veritascorp.com | 416-866-8783 4

 Head of Research

Sam La Bell, MA, MBA, CFA

slabell@veritascorp.com

Accounting & Special Situations Group

Anthony Scilipoti, FCPA, FCA, CPA (Illinois)

ascilipoti@veritascorp.com

Dimitry Khmelnitsky, CPA, CA Howard Leung, CPA, CA, CFA

dkhmelnitsky@veritascorp.com hleung@veritascorp.com

Taso Georgopoulos, CPA, CA, CFA Nigel D’Souza, B.Sc.

tgeorgopoulos@veritascorp.com ndsouza@veritascorp.com

Frank Meng, CPA, CA

fmeng@veritascorp.com

Consumer Staples & Consumer Discretionary Energy & Special Situations

Kathleen Wong, CPA, CA, CFA Nima Billou, MBA, CFA

kwong@veritascorp.com nbillou@veritascorp.com

Ahmad Faheem, Honours BBA Jeffrey Craig, CPA, CA, Honours BBA
afaheem@veritascorp.com jcraig@veritascorp.com

Industrials, Utilities & Special Situations Financial Services

Darryl McCoubrey, CPA, CA Mike Rizvanovic, CFA

dmccoubrey@veritascorp.com mrizvanovic@veritascorp.com

Nasiba Akhmedova, MBA Sherry Ye

nakhmedova@veritascorp.com sye@veritascorp.com

Dan Fong, BA, HBA, CFA

dfong@veritascorp.com

Precious Metals Telecommunications & Technology

Sid Subramani, P. Eng, MBA Desmond Lau, CPA, CA, CFA

ssubramani@veritascorp.com dlau@veritascorp.com

Client Support & Business Development

Stuart Rolfe, B.A.Sc.

srolfe@veritascorp.com

Veritas Investment Research Corporation ("Veritas") its directors, officers, employees and their immediate families are prohibited from trading any position in the securities profiled in a
report thirty (30) days before and five (5) days after the publication date where the report involves coverage initiation or a change of opinion. Veritas has not offered any consulting,
financial advisory, investment banking or underwriting services to the companies mentioned. Veritas does not accept research fees from the companies profiled herein. The
information contained in this report has been obtained from sources believed reliable however the accuracy and/or completeness of the information is not guaranteed by Veritas, nor
does Veritas assume any responsibility or liability whatsoever. All opinions expressed are subject to change without notification. This report is for information purposes only and does not
constitute and should in no way be construed as a solicitation to buy or sell any of the securities mentioned herein. The contents of this research report do not, in any way, purport to
include any manner of legal advice or opinion. The intention of this report is to provide a forthright discussion of business, accounting and financial reporting issues, as well as generally
accepted accounting principles and the limits of their usefulness to investors. As such, please do not infer from this report that the accounting policies of any company mentioned
herein are not allowed within the broad range of generally accepted accounting principles, or that the policies employed by that company were not approved by its auditor(s). This
report may not be reproduced in whole or in part without the express prior written consent of Veritas. Veritas is a 100% employee owned firm. ©2016 Veritas Investment Research
Corporation.

Veritas Investment Research, 100 Wellington Street West, TD West Tower, Suite 3110, P.O. Box 80, Toronto, Ontario , M5K 1E7, 416-866-8783, www.veritascorp.com
 Our Vision
To seek the truth from the facts.

Our Mission
To be our clients' trusted source
of independent knowledge and advice.

Veritas Investment Research Corporation

TD West Tower
100 Wellington Street West Suite 3110, PO Box 80
Toronto, Ontario, Canada M5K 1E7

416.866.8783
www.veritascorp.com