National Post (National Edition)
Housing a potential bright spot for Big Banks.
TORONTO • As investors adjust to the impact of low oil prices on the loan books of Canada’s banks, sectorwatchers are beginning to look at the housing market and heavily leveraged consumers as the next potential areas of concern for the country’s biggest lenders.
But as the Big Six begin rolling out year-end earnings on Tuesday, kicked off by Bank of Nova Scotia, at least one analyst sees residential real estate as a potential bright spot.
“(The) housing discussion could be positive for a change,” Gabriel Dechaine, an analyst at Canaccord Genuity, told clients in a note.
“We believe recent regulatory changes and the surprise rise in (long-term) rates have improved the earnings outlook for the Canadian mortgage business,” the analyst wrote. Dechaine expects the big banks to benefit from “lessened competition” as new mortgage insurance rules push smaller firms whose primary business is mortgage finance to the sidelines. Additional benefits could come in the form of potentially rising rates that would improve margins.
Ottawa unveiled a series of measures this fall aimed at cooling Canada’s soaring residential real estate market, which has been fuelling a debt binge by consumers in the prolonged low interest rate environment.
The changes, which include requiring many borrowers to qualify for mortgage insurance at a rate higher than their contract mortgage rate, immediately caused several mono-line mortgage providers to reduce expectations for loan volume growth. These channels are expected to take a hit due to the anticipated impact of the new rules on firsttime homebuyers and the mortgage broker channel.
The big banks, meanwhile, are expected to feel less impact, and to respond, as some have already begun to do, by raising the rates charged to homebuyers on certain loans.
If the U.S. Federal Reserve or the Bank of Canada start to raise interest rates, that could also help bank margins, particularly for those with operations in the United States. But rising rates could also hurt the ability of some borrowers to repay their loans, and Dechaine said he expects banks executives to indicate the point at which rate increases would become a concern, “specifically as it relates to consumer debt affordability.”
This tipping point is crucial as analysts try to gauge the impact on the banks’ uninsured and unsecured consumer lending portfolios including credit cards and auto loans.
Other analysts who track Canada’s banks aren’t as optimistic as Dechaine about the potential growth prospects.
Peter Routledge, an analyst at National Bank Financial, said growth is likely to be tempered by early indications that some real estate markets are already slowing. He also noted that the federal government is on a path to include the financial institutions in risk-sharing on insured mortgages.
“The recent changes enacted by the federal Department of Finance with respect to mortgage finance (including risk sharing), coupled with material signs of deterioration emerging within the Vancouver housing market, signal an environment with questionable growth prospects,” Routledge said in a note to clients.
John Aiken, a bank analyst at Barclays Capital Inc., told his clients that the operating environment for Canada’s big banks is likely to remain challenging into 2017.
Though there has been some relief on the oil front, with the price per barrel climbing from February lows, the analyst noted that the price remains more than 55 per cent below where it was in mid-2014.
The weak oil price is weighing on Canada’s economy, and even job gains over the past year appear to be largely part-time, Aiken wrote, adding that the economic picture “tempers the outlook for consumer and business spending.”
He said any dampening of domestic mortgage credit growth resulting from the new federal rules will have an impact on the banks, since mortgages represent the bulk of their loan books.
Rob Sedran, an analyst at CIBC World Markets, said he expects the banks to report average year-over-year earnings growth in the low single digits, at three per cent, for the fourth quarter. His estimate represents a two per cent decline from the previous quarter of the fiscal year, driven by an expectation of seasonally higher expenses, moderately rising loan losses, and lower capital markets revenue after a strong third quarter.
The banks have been countering the slow-growth environment by cutting costs, even as they have been spending on technological improvements. Restructuring charges at banks including Toronto-Dominion Bank, Bank of Montreal, and Bank of Nova Scotia have been common over the past year or so, as staff from legacy paperwork-heavy jobs have been let go as customers do more of their banking online.
Sedran said the benefits are beginning to be seen, and he anticipates a lift in fiscal 2018 as the focus on spending less for each dollar earned continues.
“We … expect further progress will have been made on efficiency ratios,” the analyst wrote of his more bullish longer-term expectations for the big banks.
“Our forecast calls for average earnings growth to improve to just above six per cent.”