Banks show restraint on mortgage rates one year after Flaherty's warning

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A year after being admonished for cutting mortgage rates too aggressively, banks are demonstrating a new, self-imposed restraint.

In March, 2013, Bank of Montreal dropped its five-year mortgage rate to 2.99 per cent, spurring Manulife Bank to follow suit as the all-important spring housing season kicked off.

Enraged because he had been trying to slow the market, Finance Minister Jim Flaherty intervened, criticizing lenders who slashed rates and publicly praising those who held pat. It was the second year in a row that a mortgage-rate war kicked off as spring approached.

This year, there is little evidence of a similar battle for market share. Mortgage rates typically follow five-year bond rates, but while bond yields are falling, banks are demonstrating little eagerness to engage in a race to the bottom for mortgage customers.

While some lenders are cutting rates, the big banks are staying well above the 3-per-cent threshold that triggered Mr. Flaherty's ire. The lowest five-year fixed mortgage rate offered by a Canadian bank is now 3.49 per cent.

More importantly, bank executives are now much more willing to publicly state that a consumer lending slowdown is good for the country. Several warn that high levels of consumer debt could ultimately pose problems for the broader economy.

"The Canadian economy continues to fare relatively well against other global economies, with solid growth and relatively stable unemployment levels," Royal Bank of Canada chief executive officer Gordon Nixon said last week. "However, we are seeing a slowing consumer lending environment, which frankly is a good thing."

A number of bank executives stress this sentiment has been shared for years, only in private. "When you look at the pros or cons, you're much better off having a mortgage market that slows down than having it turbocharge and blow up in your face like it did in the U.S. and U.K.," said one executive who spoke on condition of anonymity.

The banks say there has been silence from Ottawa on the issue of mortgage rates, perhaps because the sector has already slowed. Quarter over quarter, mortgage lending growth has cooled to about 1 to 1.5 per cent across the industry.

The slower growth comes after Mr. Flaherty tightened mortgage insurance rules four times in as many years in the wake of the financial crisis, most recently in July, 2012. Each round made it a little bit harder to get a mortgage – for instance by capping the maximum length of an insured mortgage at 25 years.

The banks could be spurred to cut mortgage rates if bond yields fall further, but for now they are showing signs of restraint. The spread between their lowest five-year mortgage rate and the underlying bond yield is roughly 0.20 percentage points more than the equivalent spread last year.

Meridian, the largest credit union in Ontario, has already slashed its five-year rate to 2.99 per cent. Bill Whyte, Meridian's chief member services officer, said he would be surprised if more lenders don't lower their rates as the key spring selling season approaches.

However, other prognosticators, such as bond giant Pimco, expect mortgage rates to rise this year. Ed Devlin, head of Pimco's Canadian portfolio management, said in an interview Monday that he expects to see house prices, which have been on a tear, start to dip later this year and fall by 10 to 20 per cent in real terms over the next three to five years, largely because of higher mortgage rates.

The banks can afford to be more cautious this time around. In previous years their earnings growth depended on lending. Lately they have proven they can rely on other units, such as wealth management and capital markets, to boost their bottom lines. Three of the five big banks that already reported this earnings season announced record profits, even with a slowdown in consumer lending.

Mr. Flaherty declined to comment for this story, but he made his views well known last March. "I encourage responsible lending," he said at the time, saying the government of Canada is exposed to mortgage losses because the federal government backstops the mortgage insurance system.