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The Canadian housing market will avoid a U.S.-style meltdown, but a slowing real estate market will weigh on the earnings power of the country's largest banks, according to Barclays Capital.
"Our outlook is a good news/bad news scenario in that we believe that a precipitous drop in housing prices (á là the U.S. market circa 2008/2009) is unlikely, however, mortgage volume growth is likely to slow, eliminating the strong tailwind that has aided the Canadian bank's earnings and supported their valuations for the past three years," analyst John Aiken said in a note to clients Friday.
Aiken expects housing prices to fall around 5 percent. He says home prices in Canada have increased 180 percent since 1990 and more than 250 percent in British Columbia and the hot Vancouver market.
"We believe that the market views the price appreciation to be much higher than what the actual figures imply," he says.
A report released today by Statistics Canada shows two thirds of households had outstanding debt. With the Bank of Montreal offering a 5-year mortgage at 2.99 percent, Aiken says BMO -- and other banks attempting to match that low rate with similar deals -- could be putting themselves at risk.
"We believe that time remains for the situation to ease before it becomes critical, with the Fed (and, presumably the Bank of Canada) on the sidelines for some time. The pricing war that has developed heading into the spring does not increase credit risk from our standpoint but could irrevocably impair long term profitability if it is sustained," he said.
"Household de-leveraging will occur in Canada. However, it is more likely to occur over several years, not several quarters as occurred in the U.S. out of necessity."
Aiken says that while the Canadian housing market will avoid a crash, a slowdown in new mortgages will have an impact on the country's banks. Exposure to housing markets as a percentage of total loans sits between 30 and 45 percent for the country's largest banks.
National Bank, CIBC and TD are the most exposed of the Big 6.
"Regardless of whether Canadian housing faces the prospect of a bursting bubble or simply much slower growth over the coming years, the banks with the greatest relative exposure bear higher risks in both cases," Aiken says.