Tough times for Canadian mortgage stocks

Canadian housing sales activity continues to be above historical averages

Canadian mortgage companies continue to be a tough place to navigate for investors due to recent weakness throughout the economy stemming from the pullback in energy, as well as high housing activity and value growth in several key markets.

The sector has significantly underperformed the broader financial space to date in 2015, reflecting cautious sentiment toward Canadian housing in general, and the higher level of short positions for mortgage brokers and insurers.

TD Securities analyst Graham Ryding recently downgraded a number one industry player, Home Capital Group Inc., leaving First National Financial Corp. as the only buy-rated name one of the mortgage companies he covers.

Those information mill down typically 24 percent this year, versus a four-per-cent decline by the S&P/TSX Capped Financials index.

Although Ryding believes a gentle weakening phase is the most likely scenario for the Canadian housing industry, he thinks discounted multiples for mortgage sector stocks work. He also sees the opportunity of a more material correction when the economy weakens further or interest rates move much higher or faster than anticipated.

The analyst noted that housing valuations remain very elevated by approximately range of 10 % to 30 percent. He also cited the widely held view that top leverage among Canadian households poses a risk.

Meanwhile, Ryding noted that sales activity remains above historical averages, despite other signs indicating the housing industry is still pretty stable, including reasonable mortgage credit growth, stable house-price gains outside of Toronto and Vancouver, and low mortgage arrears.

\”Absent a macro-economic shock, we believe that a softening phase is the most likely scenario for the broader Canadian housing market,\” the analyst said. \”However, persistent energy price weakness and soft economic development in 2015 to-date give us some pause.\”