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Posted May 7, 2019 by Geoff Zochodne

What the spring real estate market will tell Canadian banks about their whole year

Canada's big banks are eagerly watching the country's real estate markets for evidence of a rebound this spring, but the mixed signals the sector has delivered so far are unlikely to move the needle for lenders, industry watchers say.

According to recent data, numbers for housing sales shot up in Toronto and Montreal in April but took a serious tumble in Vancouver. For the big banks, whose results are often influenced by real estate markets as well as the broader economy, it may take a steady flow of housing market gains before they see a trickle-down effect in their own profits and share prices.

"It does not swing factors either way," said John Aiken, an analyst at Barclays Capital, in a phone interview. "So I think that what we're looking for is a continuation to the trend that we've seen over the last 12 months, which was really ongoing deceleration, but not falling off of a cliff in terms of the growth they're getting out of the residential mortgages."

The mixed results so far also reflect that Canada's housing market is really made up of several regional ones.

Bank of Canada Governor Stephen Poloz noted this phenomenon in a speech on Monday, saying that "some previously frothy markets are still adjusting to a significant shift in price expectations, while other markets appear to be operating in a manner consistent with market fundamentals."

Poloz also suggested more "diversity" in mortgage durations in his speech, such as longer-term loans that would allow borrowers to renew them less frequently.

While the overall picture for housing is patchy, National Bank Financial analyst Gabriel Dechaine noted that volume data can provide a sense of where mortgage growth is going and that there have been positive indications from two of the three biggest Canadian markets, Toronto and Montreal.

The Toronto Real Estate Board reported Monday a nearly 17 percent increase in home sales in April as compared to a year ago. Montreal, meanwhile, saw home sales increase 11 percent in April 2019 compared to April 2018, the Québec Professional Association of Real Estate Brokers announced earlier this month.

That good news was tempered by the Real Estate Board of Greater Vancouver has reported last week that residential home sales in the region fell last month by 29.1 percent year-over-year.

"Just having the GTA moving higher is a good signal," Dechaine said in a phone interview. "And it's a good signal because numbers have been deteriorating, and it's also a good signal because it looks like maybe some of the impacts of mortgage-underwriting guidelines have maybe worked its way through the market."

The revised guideline, known as B-20, included a stress test for uninsured mortgages that came into effect last year.

Consumer lending has slowed since those new rules were put in place, "however, the pace of slowdown for the last eight months has been receding and lending has recently stabilized around the three percent mark," wrote Eight Capital analyst Steve Theriault in a recent note.

"Looking ahead, the spring activity (i.e., the high season for housing and auto activity) should serve as a good guide on what to expect in terms of consumer growth for bank fiscal 2019," Theriault added.

While it is still early, this year's spring mortgage season, in addition to being a bellwether, comes after some of the Big Six banks fell short of earnings estimates for the first quarter, as volatility in the markets and higher provisions for credit losses weighed on results.

Bank valuations may have been "grinding higher," CIBC Capital Markets analyst Robert Sedran wrote in a report Sunday, but they "lag the performance for the S&P/TSX composite by about 200 basis points … uncommon ground over the last several years but still better than the U.S. banks with which they are often compared."

Aiken said investors are looking at the "growth environment" for the banks. In Canada, that environment has been underwhelming.

"If you've got, call it low single-digit growth on residential mortgages, it's very difficult to get excited about overall growth in the domestic marketplace because it's going to take a lot of work elsewhere to improve upon that," Aiken said.

But if the banks can manage greater mortgage growth, it could translate into greater profits and possibly act as a catalyst for their stock prices.

"If we continue to see green shoots to something better on the housing front, that could actually help drive a re-rating of the sector," Dechaine said.

There is bound to be talk about the housing market when the big banks begin reporting their second-quarter financial results later this month.

With the possible exception of Bank of Montreal, which already had a strong start to its fiscal year, Sedran said they are expecting a better showing from the banks for their second quarter, which ended April 30.

"That said, after a weak Q1/F19, the results had better show better trends," he added.

*Originally published in the financial post by Geoff Zochodne on May 7th, 2019