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Despite rising interest rates and various policy measures implemented to slow down pricing growth, the Canadian housing market is not on track for a sharp decline. It nonetheless bears watching, as the domestic mortgage market is a big factor for the Canadian banks.

This business accounts for anywhere from 30 per cent to 60 per cent of their total lending portfolios, with CIBC and Royal Bank having the greatest exposure among the Big Six Canadian banks, and Bank of Montreal and Toronto-Dominion Bank being the least exposed. However, given the structure of Canadian mortgages and the composition of the banks’ portfolios, analysts are confident that a credit event remains remote.

John Aiken at Barclays noted that while interest rates have risen following the Bank of Canada’s two recent hikes, rates remain at very low levels, and the country’s affordability index is well below its long-term average.

“The market remains well in balanced territory, able to withstand incremental declines in demand,” Aiken told clients on Tuesday.

The introduction of a foreign home buyers tax in the Greater Toronto Area did put a dent in both volumes and pricing during the summer, but it appears to have simply made the typical seasonal slowdown worse. Data from August indicated some signs of stabilization, so the situation in Toronto looks like it will follow the path of Vancouver: a temporary pullback as the market adjusts to the new reality, with growth quickly resuming.

But rather than focus on pricing when assessing the risk Canadian housing poses to the banking sector, Aiken instead believes employment is the key.

Not only is economic growth on the upswing, but the employment situation is improving, and he expects that will continue unless the Bank of Canada takes an aggressive stance on rates. The analyst noted that rising unemployment levels in early 2000, and during the most recent economic downturn, coincided with weaker mortgage credit growth.

Employment saw modest gains in August, with 22,000 jobs added, bringing Canada’s unemployment rate down to 6.2 per cent – matching the low of October 2008.

Investors should also keep in mind that average resale home prices in Canada are up approximately 63 per cent since 2008, and home re-sale activity has climbed 16 per cent.

Since residential mortgages make up the bulk of consumer lending portfolios at the Big Six banks, any weakness in the housing market naturally poses a risk. However, the typical Canadian mortgage holder remains conservative, and Aiken thinks that could mitigate some of the potential credit risk from a weakening housing market.

Canada’s debt-to-income level is high – something housing market bears often bring up when making the case for a crash or pullback, but Aiken pointed out that “middle class” mortgage holders with incomes ranging from $58,000 to $108,000, and those above that level, account for more than 90 per cent of home buyers.

So while million dollar homes in Toronto and Vancouver get a lot of attention, the average price of homes purchased in 2016 was around $376,000, and purchases of million dollar-plus homes accounted for only about two per cent of the total.

Aiken also noted that roughly 75 per cent of Canadian mortgage holders made a down payment of 10 per cent or more, while Mortgage Professionals Canada estimates that more than half of homeowners made down payment of 20 per cent or more.
Excluding home that required no financing, the average finance ration was 78 per cent.

As a result, it would require rather substantial decline in housing pricing for Canadian households – and the banks – to encounter meaningful credit risk losses.

Source: Financial Post