Measures to cool Canadian housing market good for banks: Fitch Ratings

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Canadian banks have navigated through weak economic growth, low interest rates and a depressed energy sector with their profits intact, but one big threat remains: the domestic housing market.

Most observers believe the market is overheated, especially in Toronto and Vancouver, at a time when policy makers are introducing measures to cool things down.

But Fitch Ratings believes that if the cooling measures are good for the housing market, they'll be good for the banks as well – offering a remarkably soothing view for investors.

"To the extent that this creates an orderly slowdown in the pace of home price appreciation or even modest correction, this may be viewed as supportive to current Canadian bank ratings," the credit rating agency said in its 2017 outlook for the sector.

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The outlook follows generally upbeat fourth-quarter results from the big banks, punctuated by Bank of Montreal's season-concluding earnings report on Tuesday. BMO reported a profit of more than $1.3-billion, up 11 per cent and ahead of analysts' expectations.

The sector's strong showing has driven the S&P/TSX banks index to a record high this week and up more than 21 per cent in 2016, as concerns about low oil prices and their impact on the broader economy have subsided.

Perhaps concern about the housing market is the next to go.

In one of the key changes to the market, the Canadian government announced in October that it is considering a lender risk-sharing proposal, which would put the banks on the hook – rather than just taxpayers – for some losses when a homeowner defaults on an insured mortgage.

Fitch estimates that Canadian home prices are overvalued by a remarkable 25 per cent, implying that there is a lot of downside risk should prices correct.

Comments on the proposals are expected to close at the end of February. Fitch then expects that implementation will apply to new mortgage originations, phased in over a five-year period.

If house prices fall sharply under a particularly grim scenario, then Canadian banks will suffer, and Fitch warned that a severe downturn in the market could affect its ratings on individual banks.

But the agency's base case calls for a cooling housing market, leading to a slowdown in mortgage lending activity and a deterioration in credit performance.

"The mortgage business has been a strong area of loan growth over the past several years and solid contributor to earnings. As such, moderate price corrections or a slowdown in the housing market could potentially impact earnings and loan growth for all the banks," the agency said in its outlook.

But this isn't bad news. Fitch, which rates the banks as "stable" for 2017, believes that government actions should be seen as supportive of the long-term stability of the Canadian banking system. This is good for banks, even if their profit growth takes a near-term hit.

As well, Fitch points out that the banks have a diverse range of businesses across the country.

"These banks are price leaders benefiting from their solid franchises in key markets and business segments. This allows them to ensure appropriate risk-returns while keeping a focus on the quality of their businesses," Fitch said.

Even though the banks' growth is constrained by a slow economy – GDP growth is expected to creep up by just 2 per cent in 2017, up from expected growth of 1.6 per cent in 2016 – bank profits are sound, in their view.

"Fitch Ratings expects Canadian banks to maintain their focus on solid risk management and good capital position to ensure strong buffers against risks, which should continue to deliver stable credit performance," it said.