As banks start to report, all eyes on mortgages

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As Canada's major banks begin reporting fourth-quarter earnings this week, much of the attention will focus on mortgages, and how well the sector is holding up amid a slowing market.

Analysts and investors have been watching closely for the past few quarters to see what impact the federal government's efforts to cool the housing market are having on the country's biggest lenders. Signs of a slowdown were expected to emerge last quarter, but the banks produced some surprisingly strong revenue numbers. This time, analysts believe the cooling effect will finally take hold.

"We expect the slowdown in Canadian housing to come into sharper focus," TD Securities analyst Jason Bilodeau said in a research note previewing the fourth-quarter earnings. "The housing slowdown now appears to be upon us. Recent data, industry contacts and anecdotal evidence all seem to indicate that housing and mortgage activity is softening."

Mortgage growth has been a key driver of bank earnings over the past two decades, driven by consumers who were eager to borrow, which caused home prices to double in that time. "Over the last 20 years, the unimpeded expansion of household credit has fuelled exceptional profit growth at the Big Six Canadian banks," National Bank Financial analyst Peter Routledgesaid in a research note.

However, as the market for mortgages tightens, analysts are expecting growth to drop. Mr. Bilodeau is forecasting a slump into the mid- and low-single digits. "We expect it to be a key theme and concern as we move into 2013," he said.

Royal Bank of Canada, the country's largest lender, kicks off the quarterly earnings season Thursday. Bank of Montreal, Toronto-Dominion Bank, Canadian Imperial Bank of Commerce, National Bank of Canada and Bank of Nova Scotia report the following week.

Concerned about an overheating housing market and record consumer debt, Finance Minister Jim Flaherty moved this spring to change the maximum amortization on a government-backed mortgage to 25 years from 30 years. Home buyers who want to take out a longer mortgage must now put down at least 20 per cent of the home's price. Mr. Flaherty also reduced the amount consumers can borrow against their house in a refinancing to 80 per cent, down from 85 per cent.

Analysts expect these changes will weigh on bank profits. "While we do not see a housing crash on the horizon, we do believe that lower sales volumes and, at the very least, a deceleration in price increases will moderate demand for mortgages in particular," Rob Sedran, an analyst with CIBC World Markets, said in a note to clients.

Amid expectations that the Canadian mortgage market would eventually slow, banks have been buying assets in other industry segments to buffer against a slowdown in domestic lending. BMO and TD have expanded aggressively in the United States, while Royal Bank recently announced it was expanding its auto finance business.

Despite expectations of slowing mortgage growth, though, there are some signs that the market has remained strong in recent months. Recent Bank of Canada statistics show total residential mortgages at Canada's chartered banks grew more quickly in August than the average over the past 10 months. Mortgage balances rose 0.74 per cent in August, while the average for the past 10 months was 0.56 per cent.

While that is only one small slice of data, it shows that the banks have been able to continue to keep the mortgage taps flowing after the government's changes. Mr. Sedran is predicting a "solid" quarter for the sector. "The year-to-date results have clearly shown that bank earnings have remained resilient in the face of significant economic challenges," he said.

But Mr. Bilodeau expects the lending slowdown will take a greater toll. "Expect one of the least impressive quarters we have seen in a while," he said. Earnings per share "are likely to be down on the quarter across the board."