RBC holds off Canadian fixed income rivals

The overheated Canadian housing market is vulnerable to a correction that would ripple through the economy and the financial sector, likely hitting non-bank financial institutions the hardest, suggests a report published Monday from Toronto-based credit rating agency DBRS Ltd.

The DBRS report examines the state of the housing market and the potential implications of a downturn in that market on the financial system. Credit growth in Canada over the past five years is “comparable to the U.S. experience” in the years leading up to the global financial crisis (2002 to 2007), according to the report.

This strong credit growth has led to elevated risks in the Canadian housing market. “A sharp and durable correction in the Canadian housing market could have adverse macroeconomic implications: negative wealth effects and corrective deleveraging could dampen consumption and investment, employment in housing-related industries could contract, and bank asset quality could deteriorate,” the report says.

DBRS believes the “most vulnerable participants” in the Canadian housing market are “the specialized banks and monoline lenders, given their dependence on confidence-sensitive wholesale deposits and an active securitization market, respectively,” the report says.

There are key differences between the Canadian and U.S. mortgage markets, the report notes, including efforts by Canadian policymakers to tighten credit standards, and by the large Canadian banks to slow credit growth.

Among the big six banks, Canadian Imperial Bank of Commerce (CIBC) is most exposed, the report says, because the bank has seen its credit growth accelerate at a time when the other big banks have been pulling back. “While these factors leave CIBC more exposed to a housing downturn compared with the Big Six, DBRS believes CIBC would be able to navigate the potential downturn given its diversified loan book and strong liquidity position,” the report says.

Additionally, the report also suggests that a market downturn could “stress mid- to small-sized bank and credit union balance sheets.”

Specifically, the report says, “A downturn would most severely affect the liquidity position of specialized banks given the concentration of real estate loans on their balance sheets and their dependence on confidence-sensitive sources of funding, which could be difficult to refinance in the event of a sharp housing correction. Additionally, reliance on mortgage origination revenues and securitization activity could also affect the operations of non-bank financial institutions.”

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