RBC Did What?

Mega-lender RBC announced today that it is raising 2- to 5-year fixed rates by 10 basis points and variable rates by 15 bps. (A basis point is 1/100^th of a percentage point.)

Is this a practical joke? RBC is lifting mortgage rates despite 5-year bond yields nearing four-month lows?

That’s what many may be asking, but this is no joke. Government bond yields might guide fixed mortgage rates most of the time, but we’re in exception territory at the moment.

RBC has attributed its increases, in part, to “changes in market conditions driving increased short-term funding costs and long-term/wholesale funding costs.” That is not code for “I’m a big greedy bank.” No. RBC is reacting to an increasingly inhospitable lending environment, one where:

• Investors are demanding bigger risk premiums as global financial risks mount
  • Check out these two widely followed credit risk measures, for example:
    1. The Ted Spread → Chart
    2. The CDX Spread → Chart
• Short-term rates, in general, are stubbornly climbing
  • See the 3-month bankers’ acceptance rate, for example, which is rising despite growing chances of a Bank of Canada rate cut. (That doesn’t usually happen.)
• The probability of a Bank of Canada rate cut is rising
  • Believe it or not, the market is now pricing in a 26% chance of a -0.25% overnight rate by year-end (yes, that’s a negative 25 basis points, or 75 basis points lower than where we are today).
  • Further rate cuts would pressure bank profits, and if banks sense that coming, they may position their rates ahead time.
• Risks are mounting with respect to household debt and housing valuations
  • When the risk of financial instability goes up, two things happen:
    1. Mortgage investors demand higher rates
    2. Fewer investors want to buy mortgages—which makes the funding market less deep (i.e., less “liquid”) and, in turn, raises funding costs further.
  • While we’re not privy to current phone calls between federal policy-makers and banks, the Finance Department has in the past urged banks to show restraint on mortgage discounting, so as to not exacerbate Canada’s housing imbalances.
• Securitization and capital costs are headed higher
  • The Department of Finance recently announced rules that will make it more expensive for major banks to sell mortgages to investors and hold them on their balance sheet. That’s on top of rising costs to issue mortgage-backed securities, which many lenders use to fund their lending.

What should you make of all this as a mortgage shopper? Keep five things in mind:

1. If you have a prime – 0.75% (or better) variable rate, consider yourself blessed.
2. As we wrote in November, there’s a greater chance of variable-rate discounts shrinking than improving in coming months. If you want to play the rate cut possibility with a variable-rate mortgage, you’ll notice that RateSpy lists a slew of lenders and brokers at 2.05% or less. This is an exceptional rate given today’s events, and it may not last.
3. If you like variables, consider a 1-year fixed instead. It’s cheaper up front (1.99% or less) and it could buy you time until variable-rate discounts improve again—which they will, in time, I promise.
4. Not all lenders will follow RBC’s lead, so if you’re mortgage shopping, don’t stress just yet. Besides, if bond yields (watch them here) make new lows before the Federal Reserve hikes rates again, we will see fixed rates drift down.
5. Don’t let RBC’s new 3.04% advertised “special offer” rate fool you. We are not in an economic environment where 5-year fixed rates above 3% are sustainable.

Till next time, happy mortgage shopping and save a beep (basis point) where you can.