For years, investors who have predicted the end of Canada’s house price boom and placed bearish bets on the country’s banking sector have been wrong. Or, as they would describe it, early.
The debate has shifted sharply in 2017, however, and the bulls are in retreat. Executives at Canada’s “big five” banks found themselves this week working to ease concerns that the country’s housing market has overheated.
Global investors’ concerns have been exacerbated this month by a run on deposits at the mortgage lender Home Capital, a Toronto-based subprime lender which is trying to recover from allegations it misled investors about mortgage application fraud.
Hedge funds that have had bearish stances on the sector maintain there are parallels with New Century, the US subprime lender whose failure in 2007 was widely seen as a harbinger of the credit crisis.
Presenting second-quarter earnings on Thursday, Victor Dodig, chief executive of Canadian Imperial Bank of Commerce, said Home Capital’s difficulties “don’t reflect the Canadian housing market in general, or the performance of the broader Canadian economy”.
His counterpart at Royal Bank of Canada, Dave McKay, highlighted that Home Capital accounted for less than 1 per cent of the county’s mortgage market and argued its difficulties were an “anomaly”. “It is not a systemic risk if that firm were to continue to experience trouble,” he said.
“There wasn’t a credit reason to drive the liquidity challenges that Home Capital faced, but more a lack of confidence.”
Not everyone was reassured. “I don’t think you can conclude that even though they [Home Capital] are 1 per cent of the market, it won’t have an impact,” said James Shanahan, analyst at Edward Jones. “The problem is that sentiment can become reality. Financial services is a lot about confidence. If there are any cracks in confidence, it can result in contagion.”
Canadian banks earned a reputation for conservative stewardship after they came through the financial crisis in relatively good shape.
Shares have come under pressure in recent months, however. After rallying 260 per cent from 2009 lows, an index of 10 Canadian banks has dipped 8.2 per cent since February.
Home Capital is not investors’ only worry. This month the credit rating agency Moody’s downgraded the banking sector, warning of exposure to elevated housing prices and household debt burdens.
The earnings published this week showed few signs of stress in the banks’ mortgage portfolios. Indeed, lower loan-loss provisions helped the country’s two biggest banks by assets, TD and RBC, to post earnings that were better than expected.
RBC provisions for losses in residential mortgage came to a mere 0.02 per cent of its portfolio.
Still, banks are tempering home lending. Average residential mortgage balances at RBC rose 5.5 per cent to C$224.1bn (US$166.2bn) from a year ago — its slowest annual growth since the first quarter of 2015, according to Bloomberg.
Meanwhile those at Toronto-Dominion fell 0.4 per cent to C$187.5bn, the first sequential decline in two years, according to Bloomberg.
Riaz Ahmed, chief financial officer of TD, said: “We saw some cooling in the Canadian housing market in April, as sales activity slowed and more supply came to the market. We view this is a positive development for Canada and our customers.”
Bankers said efforts by the authorities to cool the market in urban hotspots was beginning to have an impact. Stephen Poloz, Bank of Canada Governor, last month suggested house prices in Toronto were “unsustainable” and policymakers have slapped a tax on foreign property buyers in the city.
Cameron Fowler, who runs BMO’s Canadian Personal and Commercial Banking business, said: “Softening in the Toronto market is a good thing and it looks like that may be where we’re headed.”
Yet analysts identified other reasons for the mortgage lending slowdown.
Mr Shanahan at Edward Jones said: “Mortgage loan growth has weakened considerably. There is some evidence that banks have tightened lending standards, but there is also soft demand.
“Household borrowers are really maxed out right now. Given that the Canadian banks have grown on the backs of the Canadian consumer, it would stand to reason that loan growth is slowing,” he added.
On Thursday, TD disclosed net income of $2.5bn, up 22 per cent from a year ago, with RBC gaining 9 per cent to $2.8bn and CIBC at $1.05bn, up 12 per cent. Capital markets businesses also supported the results.
Despite the forecast-beating figures, the market reaction was muted. Shares in TD closed up 1.5 per cent at $64.01 and Royal Bank of Canada 0.8 per cent at $93.74. Canadian Imperial Bank of Commerce fell 1 per cent to $105.24.
With signs the domestic businesses are slowing, investors are hoping the banks can compensate with expansion overseas. But there were also underwhelming performances outside Canada. Notably, Bank of Montreal’s earnings disappointed after it revealed higher losses from soured loans at BMO Harris Bank, based in Chicago.
John Aiken, Canadian banks analyst at Barclays in Toronto, said investors were concerned about slower international expansion and were fretting domestic mortgage lending would continue to decelerate.
But he added there was no evidence in the results of weakness in credit quality — meaning there was not enough clear evidence in the earnings to satisfy either the bulls or the bears.
“Neither side is seeing [yet] what they want to see,” he said.