Floating Rates

Steve Saretsky -

Canadian banks reported quarterly earnings this past week. One thing was clear, loan loss provisions are increasing, albeit from very low levels. Banks are preparing for more turbulence ahead, as highlighted by comments from Canada’s largest bank, RBC. The bank says interest rate hikes may trigger higher monthly payments for 80,000 customers with variable rate mortgages. The increases will average about $200 per month.

Public commentary from RBC adds to what we’ve been discussing in this newsletter for several months now. An aggressive Bank of Canada is poised to send shock waves to variable rate holders across the nation. Let’s unpack this a bit further.

There are two types of variable mortgage products in Canada. A floating rate variable which increases monthly mortgage payments every time the Bank of Canada raises rates. Then we have fixed payment variable mortgages which keep monthly mortgage payments the same regardless of interest rate increases. Instead, as rates rise, these mortgages will reduce the amount of principal being paid down. If interest rates rise to a point where no principal is being paid down, these mortgages get triggered, and banks will prompt you to increase your monthly payments. We are now reaching that stage.

The typical trigger rate is about 300bps higher than the original contract rate, so a lot of this depends on when you originated your mortgage. Per my good friend Ben Rabidoux, nearly 15% of total outstanding variable rate mortgages were originated between Mar 2021 and Feb 2022 at an average rate of 1.58%. If the Bank of Canada hikes rates 50-75bps as expected on September 07, you can expect quite a few borrowers will be receiving phone calls from their bank.

According to National Bank, fixed payment variable accounts for 67% of all variable mortgage product outstanding. The other 33% are floating rate variables, and they’ve already been feeling the pain. Interest rates are up 225bps from the lows, which means if you’ve got a million dollar mortgage, your monthly payments are up at least $1100 so far. Now imagine you’ve got several rental properties with floating rates. This is the unfortunate situation for some.

As more disposable income goes towards servicing rising interest costs, discretionary spending will pull-back. This will obviously slow the economy, which is exactly what the BoC wants. Let’s just hope they don’t go too far in the other direction this time. After missing the inflation call last year, and suggesting the housing boom was just pent-up demand, the BoC is getting a much needed shakeup.

Per Bloomberg, Governor Tiff Macklem has announced plans to reorganize the Bank of Canada’s governance structure by bringing in outsiders to its main policy-making council.

“In a context of increasingly complex and interconnected Canadian and global economies and financial systems, it’s vital that we as an organization constantly adapt and evolve,” Macklem said in a news release. “This change provides an opportunity both to bring fresh and diverse perspectives into the Bank’s consensus-based policy decision-making framework and to ensure the Bank’s executive team has a balanced, streamlined and effective distribution of management responsibility.”

The move represents one of the biggest changes to the central bank’s governing council in years.

Three Things I’m Watching:

1. About 67% of all variable mortgages are fixed payment. (Source: National Bank)

2. Nearly 15% of total outstanding variable rate mortgages were originated between Mar 2021 and Feb 2022 at an average rate of 1.58%. (Source: Ben Rabidoux)

3. Variable mortgages have been popular in recent years. (Source: Ben Rabidoux)

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The Saretsky Report. December 2022