Interest rates are heading higher and the Big Banks have been increasing their posted mortgage rates. This sounds like worrisome news for the Canadian housing market and stocks that are exposed to the market, but are the fears overblown?
National Bank of Canada economist Matthieu Arseneau says they are. And if he’s right, then a concern hanging over stocks such as Sleep Country Canada Holdings Inc., Leon’s Furniture Ltd., Home Capital Group Inc. and the Big Banks themselves may dissipate.
“Some pundits have been circulating inaccurate information recently. One is the affirmation that almost half of Canadian mortgages have been or will be up for renewal this year, suggesting an imminent payments shock from the rise of interest rates. This is false,” Mr. Arseneau said in a report.
He argues that it is difficult to imagine more than 20 per cent of mortgage debt coming up for renewal each year, well below the 47-per-cent estimate cited elsewhere. And the overall increase on aggregate interest payments should be a mere 0.24 per cent of disposable income in 2018.
His report offers a respite to the hand-wringing that has accompanied rising rates.
The Bank of Canada has raised its key interest rate three times since last summer, amid low unemployment and improving economic activity. As well, the yield on the five-year Government of Canada bond has risen above 2.2 per cent, from below 1 per cent a year ago.
Within the past month, the Big Banks have increased their posted mortgage rates.
The concerns: Many new home buyers could be shut out of the market and current homeowners will face heftier payments when they renew their mortgages. The Canadian housing market, already vulnerable because of high home prices and record levels of Canadian debt, will crumble.
These concerns appear to be weighing on some stocks. Canadian banks are clearly exposed to any downturn, since residential mortgages comprise about 45 of their lending activity. On average, the stocks are down 1 per cent this year.
Other companies are exposed through consumer spending. A report published by the Canadian Real Estate Association estimates that each home sale in Canada coincides with the purchase of $8,200 in new furniture and appliances within three years. If home sales tumble, presumably there will be less demand for stoves and mattresses.
This may explain why stocks such as Sleep Country and Leon’s have been struggling to gain momentum over the past year, even as they deliver upbeat financial results.
Sleep Country, which reported its first-quarter results this week, said that sales at stores open for at least one year rose 5 per cent. Profit over the past 12 months increased 13 per cent. Yet the shares have fallen 2.1 per cent this year.
Leon’s reported same-store sales growth of 2.6 per cent in the first quarter and profit rose 27 per cent, year-over-year. The shares are down 2.2 per cent this year.
Home Capital, an alternative mortgage lender, reported its third straight quarterly profit this week, after requiring a financial rescue early last year. Its total mortgage originations in the first quarter increased 33 per cent over the fourth quarter. The shares are down 18 per cent this year.
If rising borrowing costs are to blame for these uninspiring returns, Mr. Arseneau’s report should provide some relief.
Yes, borrowing costs are rising, but the impact should be slight. He forecasts two more interest-rate increases by the Bank of Canada this year, and two more next year. Similarly, he forecasts that the yield on the five-year Government of Canada bond will rise to 2.78 per cent at the end of next year.
But given these assumptions, he estimated that the increase in the aggregate interest payment will be 0.33 per cent this year and 0.37 per cent in 2019.
However, 41 per cent of variable-rate mortgage debt comes with fixed payments: As rates rise, your payments stay the same and less money goes toward the principal on your mortgage. Take this into account, and the impact on payments is just 0.24 per cent this year and 0.26 per cent in 2019.
“Considering that real disposable income has grown an average 2.5 per cent annually over the last 10 years, that’s a slight touch on the brakes,” Mr. Arseneau said.
David Berman