Housing, Home Capital front and centre
Big banks prepare to release Q2 results
When Canada’s biggest banks start reporting second quarter earnings this week, investors will be keying in on how the housing market is affecting results, and what management has to say about mortgage growth.
Whether it’s the ongoing drama at Home Capital Group Inc., or the 30 per cent appreciation in Toronto home prices, which triggered a regulatory response by the Ontario Government, there is plenty to talk about.
“Outlook commentary from the banks will hopefully address a variety of investor concerns, such as the importance of alternative lenders in the larger mortgage landscape, the impact of a potential failure of one of its participants, as well as the growth outlook for mortgages given market disruptions and regulatory actions that have been taken in recent months,” said Gabriel Dechaine, a banking analyst at National Bank Financial.
Housing market worries put pressure on Canadian bank stocks in recent months, with the group lagging the S&P/TSX Composite index by roughly 700 basis points since reporting Q1 results.
Historical trends suggest a contrarian approach might be wise at this point. However, Dechaine noted that for the sector to see broader support, bank stocks need to get cheaper.
The group’s current forward price-to-earnings multiple of approximately 11.8x is “average,” and investors want to see some sort of resolution to the Home Capital situation that has elevated fears of mortgage market contagion, due to both credit and funding risk.
Dechaine also highlighted the surprising improvement in provisions for credit losses from the banks when they reported Q1 results. Since credit card trust data points to continued gains during Q2, and employment levels are stable, he’s optimistic the trend can continue.
“In fact, we have become more concerned about emerging signs of credit quality deterioration in the U.S.,” the analyst said, highlighting rising credit card delinquencies and subprime auto loss rates — issues that could be relevant to Toronto-Dominion Bank and Bank of Montreal this quarter.
While discussion of Home Capital will likely dominate the banks’ earnings calls, Brian Klock, an analyst at KBW in Boston, doesn’t expect an impact on their Q2 results.
“However, we will be looking for qualitative colour on how the banks are positioning their mortgage portfolios,” he said. “Our expectation is that during earnings calls, bank managements will point to differences between Home Capital’s mortgage origination and funding structure, as well as the quality of the banks’ portfolios, as points of distinction.”
Home Capital is a major player in the market for Alt-A mortgages, which are usually originated through broker networks, as opposed to banks. Banks have historically had more conservative underwriting standards than brokers.
Klock believes Canadian banks’ mortgage portfolios are well protected by mortgage insurance, which can be purchased through the Canadian Mortgage and Home Corporation (CMHC), or private insurers such as Canada Guaranty and Genworth MI Canada.
The analyst estimates that approximately 60 per cent of Canada’s $1.4 trillion mortgage market is insured, and 52 per cent of the Canadian mortgages on the Big 5 banks books were insured, as of Jan. 31, 2017.
He is forecasting BMO to beat consensus expectations, and both Royal Bank of Canada and CIBC to miss the average analyst earnings per share forecast.
CIBC analyst Robert Sedran noted that Q2 typically sees a sequential earnings dip, partly because February is included in the quarter, which results in three fewer interest-earning days.
He is forecasting dividend hikes from BMO, National Bank of Canada, and Laurentian Bank, which would keep them in line with their respective every-other-quarter increases.
While the Canadian government has cracked down on foreign speculators and stress tested borrowers who take out insured mortgages, these actions may not be sufficient. Klock believes the banks will likely need to take action, perhaps in the form of tighter underwriting standards, and put them in place while rates are low and unemployment is stable.
“The Canadian mortgage market is poised to slow,” said Doug Young, an analyst at Desjardins Capital Markets, pointing to various Department of Finance efforts to rein in the housing market during the past decade.
He believes recent changes related to qualifying for mortgage insurance will cool the market through 2017, while other headwinds are on the horizon, such as the potential for risk-sharing on insured mortgages, possible changes to CMHC, and a 15 per cent tax on foreign buyers in Vancouver and Toronto.
Young estimates that residential mortgages account for roughly 56 per cent of Canadian personal and commercial bank loans for the Big 6, but this segment only represents about 20 to 25 per cent of earnings generated by their loan books.
Earnings season begins on May 24 with BMO, followed by CIBC, RBC and TD the following day, and Bank of Nova Scotia on May 30.