Canada's smaller financial institutions, including regional players such as Laurentian Bank and Canadian Western Bank that lend to higher-risk home buyers, were hit with a storm this week that came out of a clear blue sky.
Investor sentiment toward mortgage markets flipped in recent days in the wake of financial problems at Home Capital Group Inc., the country's largest lender to home owners who can't get financing from the big banks.
Financial institutions that have a booming business in giving out non-prime home loans are discovering that's no longer something to brag about. In fact, it's an activity some lenders will likely curtail.
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Fundamentals aren't driving this switch, as defaults on residential mortgages in Canada have never been lower.
Investors are simply coming to the conclusion that red-hot real estate markets are bound to cool, and that's going to mean trouble for lenders to higher-risk home buyers.
These borrowers, typically self-employed or immigrant borrowers who don't have confirmable income or credit histories, are target clients for Edmonton-based Canadian Western and Montreal-based Laurentian, along with Home Capital and its peers.
"Although we are not worried about a funding crisis developing for either Canadian Western Bank or Laurentian Bank, growth both banks are pursuing in the alternative mortgage market has become ever harder to justify," National Bank Financial analyst Gabriel Dechaine said in a report on Thursday.
Earlier this year, Canadian Western and Laurentian highlighted strong growth in their mortgage portfolios as they tabled solid financial results.
Canadian Western is expanding outside Alberta with a program called "Optimum Mortgage," which pitches home loans to self-employed borrowers. Over the past year, the bank's personal loan and mortgage portfolio grew by 17 per cent, to $4.2-billion.
At Laurentian, the residential mortgage book grew by $400-million last year to $17.2-billion and the bank said this "reflected continued growth in residential mortgage loans distributed through independent brokers and advisers."
Canadian Western and Laurentian saw their share price slide this week, with both banks' stocks underperforming their Canadian peers, as Home Capital's problems played out. Mr. Dechaine said: "Valuation of players in this mortgage space, which were low even prior to Home Capital's issues, demonstrates that a growth strategy that emphasizes alternative mortgages should be dilutive to a bank's multiple."
The sea change in sentiment around mortgages isn't related to Home Capital's woes. The Toronto-based company ran into trouble when clients began withdrawing cash from the high-interest savings accounts that Home Capital used to finance its mortgage portfolio. To offset the bleeding, Home Capital borrowed $2-billion on Thursday from a pension plan for Ontario hospital workers, and the company put itself up for sale.
In contrast, the U.S. subprime-mortgage meltdown in 2008 was triggered by home owners who got in over their heads and began defaulting on debts. Home Capital, and other alternative lenders, are currently experiencing the best of times when it comes to mortgage delinquencies.
Stock markets, however, are barometers of future results, not today's reality. The shift in sentiment on alternative mortgage lenders shows investors believe there are storms brewing in residential real estate.
If making higher-risk home loans is now a negative, a change in strategy is required at regional banks such as Canadian Western and Laurentian. And a bearish outlook on mortgage lending will make it harder to find a buyer for beleaguered Home Capital.
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Andrew Willis