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Home price correction and Canadian banks

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The Canadian housing market set off alarm bells this week, as executives at some of the country's largest banks warned of a potential pullback in prices after more than a decade of gains.

The banks' concerns hit close to home and balance sheet. Mortgage loans at their domestic operations are a large component of their retail lending portfolio and many analysts and economists expect earnings to fall as banks pull back on the number of home loans they banks originate.

"If you think about their loan books it's certainly the largest asset class that exists within that," Craig Fehr, analyst at Edward Jones, tells BNN. "Residential mortgages in Canada account for over half of their retail lending books in Canada and probably over a third of their total loan books, so certainly the Canadian housing market and mortgage growth is going to be an important factor for them moving forward."

"As the housing market goes, the growth in residential mortgages is going to be impacted, as well as the profitability."

Fehr says investors should look at the U.S. for a taste of what can happen to bank profitability in the wake of a real estate slowdown. Fehr tells BNN National Bank and CIBC are the two banks most leveraged to the domestic consumer, as they are limited by a lack of international operations to offset slower growth in their Canadian retail lending.

Robert Sedran, an analyst at CIBC covering Canadian banks and insurers, says a meaningful pullback in home prices will result "in slower earnings growth" due to a slowdown in the origination of new mortgages. But Sedran says dividends at the big banks are safe even if home prices pull back.

He adds that a housing correction will mean "dividend growth is going to slow…or it may go flat." Fehr also believes a weaker housing market will slow dividend growth, but doesn't believe we'll see any of the banks cutting their quarterly payout to shareholders.

Bank of Montreal CEO, Bill Downe told BNN this week that dividend hikes may be put on hold while the bank looks for other avenues of earnings growth.

"Because we are absorbing a very large acquisition [ of U.S. bank Marshall & Ilsley] we're rebuilding capital…and the likelihood [of a dividend hike] is low," he said. "But we made the acquisition to grow earnings and growing earnings fuel dividend increases."

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