Canadian Housing Market Signals a Weak Year for Mortgage Lenders

Canada’s housing market, teetering on the brink of a downturn, doesn’t send an encouraging signal to mortgage lenders who were hoping a rebound in sale activity this spring.

The latest housing data show that sales are down drastically in February when compared to the same month a year ago. Both buyers and sellers are struggling to have deals closed following the government’s moves during the past one year to slow down once a red-hot market after a decade-long boom.

Sales in the Greater Toronto Area, or GTA, plunged 35% from a year earlier to 5,175 units, according to data released Tuesday by the Toronto Real Estate Board. It was the weakest month of sales for February since 2009.

Benchmark prices in Canada’s largest city rose 3.2% from a year earlier, fueled by gains in apartments and townhouses. But average prices for detached homes declined 17% to $1,000,736 from February a year ago.

Canada’s biggest housing market has been cooling over the past 10 months, as the government introduced a tax on foreign buyers and the mortgage regulator made it harder for people to qualify for loans in an effort to control speculation.

From January this year, the stringent mortgage rules kicked in, which required borrowers to prove that they will be able to pay their mortgage in case the rate rises two percentage points higher than the rate they agree on with a lender. That rule, according to some estimates, will affect about 10-15% of the potential home buyers in 2018.

Analysts are also forecasting further pain for borrowers on expectations that the Bank of Canada will continue with its drive to raise interest rates in 2018.

A bad start for housing stocks

A slowing housing market, or a potential long-term slump, doesn’t bode well for Canada’s mortgage lenders, including Home Capital Group Inc. (TSX:HCG) and Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM).

These are two financial stocks that have been the target of short sellers who believe these companies will come under pressure if the housing market faces a severe downturn. Home Capital, which is putting its house in order after being bailed out by Warren Buffett’s investment firm last spring, is going to find it tough to bring back clients and repair its balance sheet.

CIBC, however, has the biggest uninsured portfolio of mortgages among the top five Canadian banks. The lender might underperform if housing activity remains weak in 2018.

The bottom line

I don’t think there is a case for a disaster scenario for the Canadian housing market, which still has a strong pent-up demand due to growing population and the economy, which is on a strong footing. But a prolonged weakness in the housing market means some banking stocks will struggle and underperform the broader market. Investors shouldn’t get surprised when they see that happening.

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Fool contributor Haris Anwar has no position in the companies mentioned.

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