Skip to main content

Reports on Canada's housing market can make for grim reading these days, especially if you're a bank investor.

In the latest, Teranet-National Bank house price index showed that prices are pointing toward stagnation, which for some observers means that the next leg is down, potentially cutting off a crucial source of revenue for banks.

According to the report, price growth slowed to 3.4 per cent in October year-over-year. That's down from 3.6 per cent year-over-year growth in September. And house prices in October actually declined slightly month-over-month.

If you're optimistic, you might see a so-called soft-landing in these numbers, where modestly declining prices lure another round of buyers into th e market, setting it on course for another profitable cycle.

David Madani, Canada economist at Capital Economics, isn't one of the optimists: He is still calling for a 25 per cent correction in house prices and can see problems in the condominium market already materializing.

Part of the problem is due to the construction of too many houses and condos, driving unoccupied units to historical highs. Given the number of cranes on various urban skylines, this problem is likely to get even worse next year.

Already, markets are creaking in terms of sales. Mr. Madani pointed out that new condo sales in Toronto fell 30 per cent in the third quarter.

"This sudden drop clearly indicates that potential investors have moved to the sidelines, while others that are already invested, such as in the highly acclaimed Trump International, are now reportedly demanding their money back," he said in a note.

If investors are concerned, it is not showing up in bank stocks. The S&P/TSX banks index is a mere 3 per cent below its 52-week high, and the index has actually risen about 10 per cent since the start of June.

To be sure, the prospect of a U.S.-style financial meltdown are remote, given that mortgages are insured by the government.

However, mortgages are a big part of bank revenues – so a drought can hurt their top line. As well, there can be economic ramifications to a downturn, given how important the housing sector is to economic activity.

The credit rating agencies are starting to express some concern about the impact a housing correction would have on the Canadian economy.

In late October, Moody's Investors Service placed six Canadian banks on review for a potential downgrade, highlighting the fact that consumer debt is at a record high of 163 per cent of personal disposable income, driven by rising house prices.

This leaves "Canadian banks more vulnerable to increased risks to the Canadian economy," said David Beattie, a Moody's vice-president, in a statement.

Mr. Madani expects that a drag from housing, along with a deterioration in the global economy, will slow Canada's economic growth to just 1.2 per cent in 2013.

It is hard to imagine Canadian bank stocks performing well under these circumstances. When house prices corrected in 1989, with the epicentre in Toronto, bank stocks tumbled about 30 per cent in the following year and generally stagnated until the mid-1990s.

Yes, there was more than housing weighing on stocks back then. But today, the backdrop is just as gloomy.