Monday, September 20, 2010

Banks hold most of the cards in mortgage game

John Greenwood, Financial Post · Friday, Sept. 17, 2010

To understand the housing market and where it’s headed, it’s a good idea to take a close look at the big banks.

As providers of more than 60% of home loans in Canada they are major players, determining everything from who gets to be a buyer to what people can afford to pay.

It’s no surprise that mortgages are the biggest single asset class held by the banks. According to the Bank of Canada, the chartered banks had $495-billion of mortgages on their balance sheets as of this month, or about half of all outstanding home loans — and that doesn’t include the billions of dollars of home loans that the banks have sold into the Canada Mortgage Bond program.

Mortgage finance is big business for the banks, and it’s also a cash cow for several reasons. For one, because banking is an oligopoly in Canada, players pretty much get to decide how much they will charge. Unlike the United States where thousands of lenders compete tooth and nail for business, the industry in this country is concentrated in the hands of the banks and the credit unions, with a handful of smaller players focusing on borrowers the banks don’t want to deal with.

Bill Downe, chief executive of Bank of Montreal, recently explained it this way to an investor conference: “We don’t believe we compete on price.”

Another reason banks like the business is because the riskiest mortgages are insured by the Canada Mortgage and Housing Corp., a Crown corporation. In the event of a worst-case scenario, it is the taxpayer who shoulders the risk of default. The idea is to make mortgages cheaper and therefore more affordable for those at the lower end of the income scale.

In practice the banks don’t pass on all the positive lift from government support to their customers.

“The system is founded on a sovereign entity that guarantees risky mortgages,” said Peter Routledge, an analyst at National Bank Financial.

In the late 1990s, the banks added a new twist to the business model as they began securitizing, or selling, parts of their mortgage portfolio. Securitization had caught on in the United States long before it did in Canada, so lenders in this country were merely copying what they saw as a proven and highly beneficial innovation.

Essentially, it allowed them to swap baskets of loans that might not pay off for several decades for a lump sum. In other words, instant liquidity, which they could then use to make more home loans. The result: The market for Canada Mortgage Bonds has jumped to nearly $300-billion today from less than $10-billion in 2001.

During the financial crisis, while private sector investors fled, the Bank of Canada and the federal government kept the securitization market going, buying up tens of billions of dollars of securitized mortgages so Canadian banks could continue to lend. It proved to be a vital lifeline to the banks during the tough times, providing a key source of liquidity that was virtually absent from the global banking system.

As a way to keep the Canadian financial system going it was a great strategy, but there were unintended consequences.

For instance, banks soon came to rely on securitization to boost their results.

According to a 2009 BMO Capital Markets report, as much of 15% of quarterly bank profits were generated by securitization that year. The problem is that such gains are but a one-time boost instead of a steady stream of interest payments that would amount to a much bigger profit if the mortgages stayed on bank balance sheets.

“This isn’t a positive development,” said the BMO report by analyst Ian de Verteuil (now with the Canada Pension Plan Investment Board).

Yet another concern is the impact on consumer behaviour. Because of the profits that mortgages and securitization generate, banks have enormous incentive to grow the business, which they do by keeping interest rates low and easing loan conditions. Consumers have responded by taking the cheap money offered and bidding up house prices across the country. So even as real estate was collapsing in the United States and much of Europe, the market in this country — apart from a brief period in 2008 and 2009 — continued to expand.

Canadian household debt compared to income is now sitting close to record levels, according to Statistics Canada, and that’s prompted a spate of warnings from rating agencies and others. This week the OECD said in a report that ballooning consumer debt has left Canadians with “growing vulnerability” to adverse economic shocks.

Meanwhile, equity markets have been treading water since the start of the year and the economic recovery is looking increasingly wobbly. In a worst-case scenario a spike in mortgage defaults would likely result in a significant housing market correction.

The good news for the banks is that they are largely protected from such a situation because the riskiest mortgages are covered by CMHC insurance.

Experts, however, say that despite the concerns, Canada’s housing market remains relatively robust.

Over the past 12 months lenders along with the CMHC have taken steps to gently tighten mortgage conditions, shortening the maximum amortization and requiring borrowers to put up more capital. As a result, they say, the froth has come off the market and “balance” has returned.

The bottom line is that “the system is moving in the right direction,” said Mr. Routledge.:

Wednesday, September 8, 2010

Bank of Canada expected to hike then pause on rates

Bloomberg · Wednesday, Sept. 8, 2010

Bank of Canada Governor Mark Carney will probably raise borrowing costs today for a third and final time this year before pausing to gauge the strength of the economic recovery, economists said.

Fourteen of 20 economists surveyed by Bloomberg News expect Mr. Carney to raise the bank’s policy interest rate by a quarter point to 1% in a decision to be released at 9 a.m. ET. Economists forecast Mr. Carney will keep the rate at that level until April, according to a separate survey.

Policy makers may be unwilling to tighten policy further as Canada’s economy expanded more slowly than anticipated in the second quarter, and as the U.S. proposes additional stimulus amid signs of renewed weakness. Mr. Carney may also signal greater risks to its projections from weakness outside Canada.

“The bank will position itself for a slower growth scenario,” said Marc Rouleau, a fund manager at Standard Life Investments in Montreal who helps manage $18-billion in fixed-income assets.

The bank’s June 1 increase, which was followed by another on July 20, was the first among Group of Seven countries after last year’s global recession. Canada has recovered from the slump faster than the U.S., having already returned to pre- recession levels of employment. Carney has said the current 0.75% rate still provides “considerable monetary stimulus.”

The bank has also warned the risks to its projections are elevated, and that future rate increases are not “pre- ordained.” Last month, diminishing prospects for U.S. growth sent global stocks tumbling and prompted the Federal Reserve to signal the possibility of adding monetary stimulus.

Canadian investors have pared bets over the past month that Mr. Carney will increase lending rates. The yield on December 2010 bankers’ acceptances contract, the most actively traded contract, has fallen to 1.14%, from 1.29% a month ago and a 2010-high of 2.02% on April 21. The contracts have settled an average of about 20 basis points above the central bank’s overnight target since 1992, Bloomberg data show.

The Canadian economy, after growing at an annualized 5.8% pace in the first quarter, slowed in the April-June period to a 2% rate -- a full percentage point below the central bank’s prediction. As well, employers cut workers in July for the first time this year and the core rate of inflation, which is closely watched by the bank, unexpectedly slowed to 1.6% in July.

Canada “remains on sounder footing than the U.S., but all eyes are focused on U.S.,” said Anil Tahiliani, a fund manager at McLean & Partners Wealth Management in Calgary, Alberta, in an e-mail. “We expect after this small increase of 0.25%, the BOC will go on hold since the economy is starting to slow and global economic concerns take front stage.”

Earnings for Standard & Poor’s/TSX Composite Index companies that have released results since July 12 have dropped 4.3% from a year ago, pulled down by Manulife Financial Corp., Canada’s largest insurer, which on Aug. 5 reported a $2.4-billion loss that was more than double forecasts.

U.S. President Barack Obama is proposing to expand tax relief for businesses and boost federal spending on transportation to help bolster the economy. In Milwaukee on Sept. 6, Obama called for US$50-billion in the first of a six-year program to fix roads and railways.

The U.S. Federal Reserve moved Aug. 10 to shore up the recovery, deciding to reinvest principal payments on mortgage assets it holds into long-term Treasuries. Policy makers put a US$2.05-trillion floor on the Fed’s securities holdings to prevent money from draining out of the financial system.

Fed Chairman Ben S. Bernanke said in an Aug. 27 speech that while the “preconditions” for stronger growth year are in place, the Fed was prepared to embark on more stimulus, such as asset purchases, if needed.

Mr. Carney may want to avoid providing too much direction to investors given uncertainty over the economic outlook, said Eric Lascelles, chief economics and rates strategist with Toronto- Dominion Bank. Canada’s GDP report showed domestic demand remains buoyant, led by investments from businesses such as Potash Corp. of Saskatchewan Inc. and Suncor Energy Inc.

“I don’t think this is the sort of thing where the market is going to come out and say, ‘Well, they are pausing with absolute certainty in October,’” said Mr. Lascelles, chief economics and rates strategist with Toronto-Dominion. “I suspect the bank does want to keep those options open.”

Read more:

Tuesday, September 7, 2010

Favourable U.S. data suggests Canadian rate increase

Paul Vieira, Financial Post · Monday, Sept. 6, 2010

OTTAWA • What a difference a week makes in gauging the state of the Canadian economy.

At the start of last week, few market players believed the Bank of Canada would raise its benchmark rate on Wednesday as concern over its largest trading partner, the United States, mounted. The U.S. economy was believed to be on the verge of flirting with a double-dip recession, given the spate of weak economic data traders had grown accustomed to over the summer.

But two key U.S. pieces of August data released last week — the ISM manufacturing index and non-farm payrolls — were better than expected and suggested the North American economic recovery, while sluggish, marches on and is in no real danger of falling into an abyss. This helped trigger a “vicious” sell-off in bonds, in which investors piled in because of fears of a severe economic slowdown.

The result: The probability that Mark Carney, the Bank of Canada governor, will raise interest rates by 25 basis points, to 1%, increased to slightly more than 60% on Friday from less than 50% as of late August.

The good-looking U.S. data “tipped the scale heavily” toward a rate hike, said Douglas Porter, deputy chief economist at BMO Capital Markets.

Also playing a role was Canadian GDP data for the second quarter, which on the surface appeared tepid — 2% annualized growth, well below the rapid pace recorded in previous quarters. But analysts say the Canadian economy is stronger than the second-quarter headlines indicated, with final domestic demand still advancing at a robust pace. Plus, much of the second-quarter drag was from so-called “import leakage,” in which gains in imports — as firms acquired productivity-enhancing equipment at the fastest pace since 2005 — outstripped exports. Income data also showed wages and salaries grew “a very solid” 4.8% annualized in the three-month period, according to economists at Moody’s Analytics.

“Although growth slowed more than expected in the second quarter, the cause of this slowing does not suggest that there has been significant deterioration in the economy’s overall health,” said John Clinkard, chief Canadian economist at Deutsche Bank.

“Given the surge of investment in new machinery and equipment in the second quarter, that [means] business confidence is strong,” Mr. Clinkard said.

Still, much doubt remains about the health of the United States. The Bank of Canada’s economic outlook, released just two months ago, now appears too optimistic given recent trends. It expected the economy to reach its full potential late next year, but that could be pushed out further with weaker economic indicators in the United States and Canada. Plus, recent data suggest inflation, which ultimately drives the bank’s rate decisions, poses no threat as the key core rate — which strips out volatile-priced items — has slowed for two straight months.

These factors are driving analysts to scale back expectations for rate hikes for the remainder of 2010 and into 2011, predicting the Bank of Canada will pause for a while to see where all the economic dust settles. For instance, Bank of Nova Scotia chief economist Warren Jestin now envisages the central bank moving its benchmark rate no higher than 1.75% next year, or 50 basis points below previous forecasts.

Last week’s U.S. data may have put to rest fears of a double-dip recession, “but we are also tracking a U.S. economy that is nowhere near the pace it needs to be at this stage of the business cycle,” said Avery Shenfeld, chief economist at CIBC World Markets. The United States still requires “easy monetary policy and a softening in next year’s planned fiscal tightening if it is going to stay out of trouble.”

Even with positive jobs and manufacturing data, the week ended with a bit of a reality check for the U.S. economy with figures showing growth slowing in the service sector, which accounts for 80% of U.S. output.

The U.S. Federal Reserve is expected to refrain from rate hikes for a while — well into 2011, according to most analysts — with the U.S. economy still in a lacklustre state. The Bank of Canada, then, won’t want to raise rates too aggressively ahead of the Fed or risk the Canadian dollar appreciating to levels that start to take a bite out of economic output.

In fact, speculation is that the Fed would inject further liquidity, through another round of securities purchases, before considering a rate hike. But senior Fed policymakers remain divided on that need, with Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, describing fears of deflation and a double-dip recession as “alarmist.”

In addition, Mr. Lockhart said that, despite all the worry, the U.S. economy remained on a “gradual recovery track.”
Read more:

Thursday, September 2, 2010

'If ever there was a time to buy, it is now,'

John Greenwood, Financial Post · Thursday, Sept. 2, 2010

Bank of Montreal has chopped its benchmark five-year mortgage rate, aggressively throwing its weight behind what many are calling an increasingly wobbly housing market.

"It's a great time to buy a home," Martin Nel, a senior BMO official, said in news release announcing the change. He added that people who take advantage of the offer will benefit.

"If ever there was a time to buy, it is now," Mr. Nel said.

The move, which takes effect today, brings the bank's key five-year rate to 3.59%, down from 3.79%, making it one of the lowest five-year rates ever offered by a Canadian bank, says industry newsletter CanadianMortgage Trends.

But some experts are already scratching their heads because of the aggressive tone of the announcement as well as the timing, given the recent spate of warnings about the uncertain state of the market, including one earlier this week from the Canadian Centre for Policy alternatives predicting an imminent collapse.

When the big banks make mortgage rate changes, they generally just disclose the new numbers without commenting on housing market conditions. If pressed, bank officials are usually quick to explain that the changes in these consumer lending rates are merely a function of fluctuations in their own borrowing costs.

"It's a bit puzzling to me," John Andrew, a professor at Queen's University's School of Urban and Regional Planning, said of the BMO announcement. "Perhaps they are concerned that the number of new customers will fall off precipitously."

Residential real estate prices have been in free-fall in the United States as well as many European countries, in contrast to the Canadian market, which has been on a tear for a good part of the past decade with prices in many cities at record levels.

But analysts worry that it's only a matter of time before the Canadian housing market moves in the same direction, and they point to warning signs that have already appeared.

Earlier this year, Moody's reported that debt-to-income levels of Canadian households are the highest ever and close to where they were in the United States before that market started to fall apart in 2007.

The Bank of Canada has raised concerns that the high debt loads of Canadian consumers have made them vulnerable to changes in interest rates and potential deterioration of the economy.

In a bid to crack down on what some described as reckless real-estate speculation, the federal government brought in new regulations in the spring to make it harder for first-time buyers to qualify for government-backed mortgage insurance.

Borrowers must now meet standards for a five-year fixed-rate mortgage, even if they want a shorter-term, variable-rate product. As the key measuring stick for many homebuyers, a lower five-year mortgage rate will mean that more people will qualify to buy more expensive homes than with a higher mortgage rate.

The tougher rules had the desired effect. The recent imposition of the new harmonized sales tax in Ontario and British Columbia also affected demand, and as a result the market cooled so much that industry insiders became worried it had gone too far.

The Canadian housing market is important to the banks because residential mortgages make up the single biggest asset class on their balance sheets.

There are nearly $1-trillion of home loans outstanding, to the Bank of Canada says. About half of these loans are held by the chartered banks.

Wednesday, September 1, 2010

10 easy ways to build a credit history

by Gail Vaz-Oxlade, for Yahoo! Canada Finance
I am constantly astounded at the number of people I meet who are in a bind because they have no credit history and can’t borrow money. This is something we used to associate with older, widowed women who have been cared for by loving, controlling spouses. But that’s just part of the story. Not having a credit history isn’t the domain on slightly out-of-touch women; there are men out there who haven’t got a clue because their wives do EVERYTHING. And it isn’t the exclusive territory of our elders; there are young, professionals who haven’t bothered to establish their own credit identities.

Everyone needs to have the ability to borrow money. That’s true whether you’ve just found yourself in the new role of single parent without an emergency fund or you’re a young adult starting out.

1. Get a Secured Credit Card. The fastest, cheapest and easiest way to establish a credit history is with a secured credit card. Since there’s no risk to the lender because you’ve put up the cash to cover your balance, secured cards are great for new borrowers or people trying to re-establish credit after a bankruptcy.

Lenders usually want twice the credit card limit. So if you want a $500 credit limit, you’ll have to ante up $1,000. Once you’ve established your ability to manage the card – anywhere from six months to a year – you can ask for the security requirement to be dropped and your deposit returned.

2. Get a gas or department store card. Gas or department store credit cards are often easier to get and can be good ways to establish credit. You must pay your bills in full and on time because the interest rates on these cards are often astronomical. But as long as you don’t miss a payment – which you never will, right? – it makes no difference what the interest rate is. Use these cards wisely and they can be a great toe-hold.

3. Borrow for an RRSP. Borrowing money to contribute to an RRSP is a great way to establish a credit history. While the RRSP cannot officially be used as collateral for the loan, lenders know where to find their money so approvals come more easily and the interest rate won’t be horrendous. Make sure you only borrow as much as you can afford to repay in six months. How much you borrow doesn’t mean much; repaying the loan quickly without a misstep does. Don’t let anyone talk you into more. Once the six months are up, use the amount you were using to repay the loan as your month retirement savings contribution. Now you’re building up your assets, which will be good for your credit history too. 4. Get a co-signer. While I’m not a big proponent of signing on for other people’s debt, if you can find someone who loves you enough to put their credit history at risk for you, do it. Make sure the loan history is being reported in your name and not the co-signer’s.

5. Put up collateral. If you have someone a lender can sell to get back his money, you’re more likely to get credit. Collateral comes in all sorts of forms: from the car you’re buying to those GICs you’ve got stashed away, if you have something a lender values, you’re in the money.

Of course, getting credit is only the first step to building a credit history. How you use that credit will be the real test.

1. Pay all your bills on time. Yes, including your cell phone bill, since some cell providers report to the credit bureau. Setting up pre-authorized payments is a great way to ensure payments are made on time.

2. Avoid applying for credit too often. Since repeated requests for credit may be interpreted as a sign that you’re in trouble and need a way to cover your butt, this will adversely affect your credit score.

3. Charge regularly and pay off in full. Responsible on-going use of credit will produce a good credit rating. Just having your card sit in your wallet does nothing to add positively to your record.

4. Don’t over-expose yourself. Having multiple forms of credit with small balances can add up quickly and become unmanageable.

5. Don’t use credit to pay off credit. Taking cash advances on one card to make payments on another means you’re in over your head. Cut back on your spending, pay off your debt and get back to the business of using credit to keep your record active and healthy, not to spend money you haven’t yet earned.