REUTERS/Kevin Lamarque/Files (UNITED STATES - Tags: BUSINESS REAL ESTATE)KEVIN LAMARQUE/Reuters
Finance Minister Jim Flaherty may be pleased that the residential housing market is losing steam, but for banks in the United States, that momentum is what's needed to combat headwinds.
One analyst thinks the U.S. real estate market has already hit rock bottom, and despite the rumblings of housing bears, believes there's already evidence of meaningful improvement. "I think it's for real, and I think it's bigger than most people realize," said Gerard Cassidy, U.S. banking analyst for RBC Capital Markets.
For banks, strength in U.S. house prices and new construction could lead to broader economic improvement.
The Achilles heel of U.S. banks in 2013 is shaping up to be the downward pressure on net interest margins. Mr. Cassidy says an improvement in the housing market south of the border could lead to increased interest rates, which would relieve some of that pressure. On Canada, though, he's less optimistic about the prospects for housing.
So far, rather than leading the U.S. out of recession as it has in the last few recoveries, housing has been a laggard.
In his research, Mr. Cassidy found that after the past few recessions, almost 50 per cent of economic growth was thanks to the recovering housing market. This time, that figure is closer to 10 per cent.
"So if you believe, like I do, that the U.S. is not Japan, and we don't have a shrinking population, and household formation has rebounded, which it has: demand for housing is coming back," he said.
For those who point to persistently high foreclosure rates as an indication that the U.S. housing market is still feeble, RBC said in its most recent commercial banks preview note that it expects early stage mortgage delinquencies to decline and foreclosures to peak in 2013.
"You might laugh at this, but in selected markets in the U.S. in the next two years, you're going to see housing shortages," he said. This will be due to population growth, but also due to job growth and people's confidence that their jobs are secure.
And if the U.S. does indeed see an improvement in the housing market, it could help combat banks' biggest issue for 2013: net interest margins. This measures the quality of a bank's investment decisions against its debt. In a high interest rate environment, with high yielding assets, the margin should be wider.
To their credit, the banks have been good at lowering their funding costs aggressively as interest rates have dropped over the past five to six years. The rates they pay for the money they use have dropped faster than the yields on their assets. And up until 2012, they were able to maintain a decent margin.
But now costs of borrowing are about as low as they can go. "This is the concern for many investors going into 2013, that if the interest rate environment stays the way it is today, that the margins will come under added pressure," Mr. Cassidy said.
But all's not lost, thanks to the promise of improvement in the housing market. "It's our belief that we're maybe at the end of [that net interest margin pressure], because if the U.S. economy comes back stronger, then we could start to see interest rates maybe go higher."
Where Canada is different from the U.S. is also in the housing market. "You guys are at the peak, and the U.S. is at the trough," Mr. Cassidy said. "Housing is the big upside surprise potential in the U.S. for 2013."
Canadian banks had better keep a close eye on the domestic housing market, and hope for a soft landing.