The drop in Canadian home prices in September may not be as severe as it seemed, TD Securities said on Wednesday, bolstering the case that the country is not headed for a U.S.-style housing meltdown TD, a unit of Toronto-Dominion Bank, argued in a report that home prices fell 1.3 percent in major Canadian markets in September, not the dramatic 6.2 percent drop that was reported by the Canadian Real Estate Association (CREA) last week.

CREA said the average house price fell to C$315,461 (about $252,000), dragged down by sales declines in Vancouver and Victoria, British Columbia, which offset rebounds in Calgary and Edmonton, Alberta. CREA said the fall came despite year-over-year gains in average home prices in 17 of 25 major Canadian markets.

TD crunched its own numbers and applied a weighting to each major city to fix "compositional shifts", which it said were behind the distorted CREA view. It said the association has acknowledged the problem.

For example, if Vancouver was the only city that reported sales in one month, and the next month Montreal was the only city that reported, then it might seem that prices had fallen in half because Montreal prices are much less expensive than those in Vancouver.

TD fixed the weight of each city to year-earlier sales levels as of September 2007.

"We wanted to get rid of the whole compositional issue. We really just controlled for the allocation. When we did that we ended up with a 1 percent drop instead of a 6 percent drop," said Eric Lascelles, chief economics and rates strategist at TD Securities.

"That's not catastrophically different, but to me that's a number that makes more sense. Yes the housing market is correcting moderately but it does not have the making of a U.S.-style correction."

He said Canadian housing starts may fall below the 200,000 mark, home prices will continue to correct in some inflated cities, but there is no need to brace for big delinquencies or a hard drop in prices.

The TD calculations aren't perfect, Lascelles acknowledged, because they do not eliminate some factors such as type and quality of home in each city.

Canadian housing data has shown signs of softness but nowhere near the slump that hit that United States, stemming from a crisis in the subprime mortgage sector.

Canadian banks are trying to convince consumers to lock in their mortgage rates because more than 20 per cent of the home loans they have negotiated have become unprofitable, according to industry sources.

The push has come after the banks cut the discount they offered to consumers with variable-rate products tied to the prime lending rate. Two weeks ago, a consumer could get a variable rate product at 0.60 percentage points below prime; today it is one percentage point above prime.

"Banks are scaring people and those people are calling asking whether they should lock in.
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Anybody with a mortgage negotiated in the past two years would be out of their mind to lock in to, say, a five-year term. They would be going from a rate as low as 3.35 per cent to 5.79 per cent. Lines of credit previously negotiated at a rate below prime are also still valid.

"If you've got a mortgage rate negotiated below prime, you have a dinosaur. It doesn't exist anywhere.
You should hold onto until the end of the term. The banks propped up all their rates 160 basis points because they knew the Bank of Canada would be lowering rates."

Last week, the Bank of Canada lowered interest rates by 50 basis points only to see the major banks cut their prime lending rate by half that amount. After some pressure, most of the banks cut their prime lending rate by the full 50 basis points.

Joan Dal Bianco, vice-president of real estate-secured lending with Toronto-Dominion Bank, said the banks were reluctant to pass on the full 50-point rate cut because they were losing money on variable-rate products.

"At the prime minus rates we were basically earning zero or negative. We kept holding off (cutting the discount)," said Dal Bianco, adding that in the past year 50 per cent of her bank's new mortgages were variable-rate products.

With a cost of funds generally above four per cent because of the lack of liquidity in the market, the mortgages previously negotiated ended up below water after the latest rate cut.

Prime is now 4.25 per cent at TD but two weeks ago the bank was offering a variable rate of 60 basis points below prime, meaning the consumer was borrowing at 3.65 per cent.

For those now entering the housing market, the rate is 5.25 per cent for a variable rate product but Dal Bianco said that might not be high enough. "We are not making much money on those if anything." she said.

The move into variable mortgages tied to prime has come in the last five year with many of the banks promoting products that allow consumers to float with prime but lock in a rate at any time during the term of their mortgage.

The Canadian Association of Accredited Mortgage Professionals says, as of 2007, 21 per cent of mortgages were variable rate, 72 per cent were fixed rate and seven per cent were a mix of the two.

Asked whether the banks are actively encouraging consumers to convert variable rate products, Dal Bianco said that hasn't happened. "We are making sure (staff) have the right conversations if people are really nervous and do not want to see their payment moving."

Another key question going forward for consumers will be whether the prime rate at the banks will continue to move with Bank of Canada's rate and nobody is guaranteeing that.

"It's not that (prime) is less meaningful, it just doesn't mean what it used to," says David Wolf, chief economist at Merrill Lynch Canada. "(Prime) is more likely to fall if the overnight lending rate is zero than if it's 2.5 per cent."

New home construction in Canada was nearly unchanged in September as a decline in single-family homes erased a jump in multiple dwelling units, and economists predicted the credit crunch would lead to a slowdown in ground-breaking.

Housing starts inched to a seasonally adjusted annualized rate of 217,600 units from an upwardly revised 217,400 units in August, Canada Mortgage and Housing Corp. said on Wednesday.

The September number beat the consensus expectation of analysts who had called for 203,000 starts. August starts were originally reported at 211,000 units.

While construction activity again stayed above the 200,000 unit mark, some analysts said this level would not likely be sustained in months to come.

"Because residential building permits tanked in August and the credit crunch reached a crescendo in September and into October, this could well be the last starts print north of 200K," Scotia Capital economists wrote in a report.

Canadian housing data has been in stark contrast with the state of the housing market in the United States, hit by a crisis that began in the subprime mortgage sector and spread across other parts of the market and the broader economy.

Economists generally expect the Canadian housing market to ease but not fall into crisis as it has in the United States, largely because risky mortgages are not a large part of the market. Even so, the Canadian economy is also expected to slow, which would likely soften demand for housing.

"This slowdown, however, is expected to be both measured and orderly, and in no way do we expect the extent of the correction to be comparable to that currently taking place in the U.S.," said TD Securities strategist Millan Mulraine.

Gains were reported across the country, except in Ontario and Quebec. British Columbia and the Atlantic provinces both reported 10 percent gains, followed by the Prairies.

Urban single home starts declined 8.1 percent to 70,000 units from 76,200, while urban multiple starts rose 5.5 percent to an annual rate of 122,500 units from 116,100 in August.

Rural starts were estimated at an unchanged seasonally adjusted annual rate of 25,100 units in September.