Are Canadian bank investors worried about the housing market?
The downturn in Toronto’s housing market appears to be drawing to a close, and if the performance of Canadian bank stocks is any indication, investors seem to agree.
Despite persistent fears that the domestic housing market was in a dangerous bubble bound to burst in a disruptive fashion, data from the Toronto Real Estate Board suggests otherwise. While resales in August remained on the downtrend relative to a year ago (falling 34.8 per cent), the annual decline was the smallest in three months.
“Those worried about a collapse in Toronto’s housing market can breathe a little easier now,” said Robert Hogue, senior economist at Royal Bank of Canada.
A declining housing market, coupled with rising interest rates, was expected to put pressure on heavily-leveraged Canadians, and therefore the lucrative lending businesses of the country’s biggest banks.
Dramatic home price gains in Toronto and Vancouver have been of particular concern in recent years.
In May, Moody’s downgraded all of Canada’s big six banks, with the ratings agency pointing to soaring household debt and elevated housing prices.
Toronto-Dominion Bank, for example, declined as much as 11.75 per cent between March and midMay.
However, despite a somewhat bumpy ride for the banking sector, the S&P/TSX Bank Industry Group Index is virtually flat on the year. It includes mortgage lenders Home Capital Group Inc. and Genworth MI Canada Inc.
The index is also up about two per cent since bottoming in mid-May, despite the dramatic pullback in home prices.
The numbers for August imply that Toronto-area resales actually rose on a seasonally-adjusted, month-over-month basis – the first increase since March. RBC estimates the gain was nine per cent.
Hogue also highlighted the fact that new listings in August fell on a year-over-year basis for the first time in 2017.
“We take this as a clear sign that the earlier wave of new listings has run its course and that the market is not at risk of becoming oversupplied,” the economist said. “In fact, the data for August points to a healthy balance between demand and supply.”
If downward pressure on prices continues to ease, investors should grow even more comfortable with banks and mortgage lenders. The recent round of quarterly results certainty helped calm some investors, as all of the banks posted profits that exceeded analysts’ forecasts.
Plenty of experts nonetheless remain concerned. David Doyle, an analyst at Macquarie, is maximum underweight the Canadian banks and domestic-focused consumer stocks.
He pointed out that the Bank of Canada’s policy shift, in the form of two consecutive 25 basis point interest rate hikes, has led to a sharp increase in the Canada five-year government bond yield – “a critical driver of mortgage rates.”
Doyle noted the five-year change in this yield approximates whether mortgage renewals are occurring at higher or lower rates.
“This has moved firmly into positive territory,” the analyst said. “Precedents (1990 and 2007) are not encouraging.”
He also highlighted the 15 per cent decline in national existing home sales volumes from their peak in March.
Doyle noted that second quarter weakness contributed to the most severe decline in residential investment of the current economic expansion, and expects the impact will be doubled in the third quarter.
“This should contribute to a slowing in leveraged consumption, which drove much of the strength in the first half of the year,” he added.