Wednesday, March 21, 2007

Citigroup Rates BMO, CIBC, & Scotiabank as Buys

Financial Post, Jonathan Ratner, 21 March 2007

While homebuyers and those that underwrite their purchases witnessed several years of steady growth in the housing market, U.S. home sales have been falling off for more than two years despite continued economic strength.

But it was not until this year that mortgage markets and many finance companies started to see a negative reaction to higher numbers of mortgage delinquencies, according to Citigroup, who says these payment problems saw their most significant increases as home sales peaked.

What some consider reckless behaviour by sub-prime lenders and buyers alike will likely impact the housing market and economy for years to come. But how substantial are the similarities between the Canadian and U.S. markets?

While more than 20% of U.S. mortgages could be categorized as sub-prime, only 5% of those originated in Canada fall into this category – serving as just one example of the significant differences for the neighbouring nations.

This means the Canadian market for below prime mortgages is worth $35-billion, compared to roughly US$700-billion in the U.S., according to Citigroup analyst Shannon Cowherd, who provided the estimates in a recent research report.

Specialty institutions, not the Big Six banks, are providing most of the sub-prime financing in Canada, which leads to little if any overlap between the two.

Meanwhile, conventional fixed rate mortgages still make up nearly 70% of total mortgages, she added.

In anticipation of weakness in credit quality, Ms. Cowherd is focusing on banks she feels have good credit risk management teams and high credit coverage ratios for loan losses.

Her ‘buy-rated’ names include Bank of Montreal with a $85 target price, Bank of Nova Scotia at $64 and CIBC at $121.

Ms. Cowherd notes the smaller Canadian population and the fewer number of firms on a percentage basis that are competing in the sup-prime space.

These primary alternative lenders include Home Capital, Xceed Mortgage and Equitable Trust, while subsidiaries of foreign banks also provide similar mortgage products.

“The ripple in the U.S. market has been driven by the residential sector,” Ms. Cowherd said. “We are comfortable with the Canadian banks exposure to the sub-prime market given it is limited to the consumer auto financing sector.”