TORONTO, March 11 (Reuters) – Canadian banks’ profit margins are expected to get a boost from an earlier-than-expected increase in mortgage rates but a sustained rise could dent home loan demand, which has been the only driver of lending growth during the coronavirus pandemic.
Most Canadian lenders have hiked fixed mortgage rates beginning last week by at least 25 basis points, with some lifting them again this week by 15 to 25 basis points in response to a 50 basis-point rise in five-year bond yields this year.
Fixed mortgages make up about two-thirds of Canadian home loans.
The increase in mortgage rates follows a year of declines to record lows that helped drive a housing boom and home loan growth, even as other lending has languished amid lockdowns and economic uncertainty.
“The fact that yields are moving up is a double-edged sword,” said Sadiq Adatia, chief investment officer at Sun Life Global Investments, who had expected increases closer to the middle of 2021.
“It generally means … there’s a light at end the tunnel,” he said. “But if it results in significant movement in mortgage rates,” it puts pressure on mortgage growth while raising funding costs.
With little demand for loans outside mortgages, banks have deployed their ballooning deposits into low-yielding short-term securities, which contributed to a decline in margins to 1.56%, the lowest in about two decades.
Residential mortgage balances at Canada’s biggest banks – Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada – grew 8.3% in the three months through January, versus a 2.4% increase in commercial lending.
While margins on mortgages are lower than on commercial loans and credit cards, they provide an entry point for banks to sell other higher-margin products.
If rising mortgage rates cause home loan growth to lose steam even as other lending remains sluggish, the margin challenges will not abate, and could even be “significant earnings risk,” said Edward Jones analyst James Shanahan.
But with mortgage rates still hovering near historical lows even after the increases, they are unlikely to significantly curtail lending growth at current levels, although the raise might take some wind out of refinancing activity, said Anne Jones, senior director for residential prime credit at smaller lender Equitable Bank.
On Wednesday, the Bank of Canada made no change to its policy rate or guidance, but acknowledged the housing market has been much stronger than expected. That has tempered expectations of rates rising ahead of BOC’s guidance.
Moody’s Senior Vice President David Beattie said he does not anticipate a persistent move higher in long-term bond yields or mortgage rates. While rising yields indicate an improving economic outlook, the recovery is expected to remain “uneven and fragile,” he said in a note.
“Will a 25-basis-point increase in the five-year rate dampen mortgage demand significantly? No,” he told Reuters. “But a 100-basis-point increase would.”
Reporting by Nichola Saminather in Toronto Editing by Denny Thomas and Matthew Lewis