The housing market is cooling, the stock market is reeling and to top it all off, consumers are now facing rising mortgage rates.
The increase means Canadian home owners are taking a direct hit from the subprime crisis, with banks passing on their higher borrowing costs to customers despite a rally in the bond market.
Volatility in stocks has led to a flight to safety, and an increase in government bond prices. This means lower yields on government debt, a trend that usually reduces borrowing costs for the banks, which in turn pass on the savings to consumers.
That trend is not playing out this time, however, as banks are instead being forced to pass on higher costs caused by the credit crunch to their borrowers, said Benjamin Tal, senior economist at CIBC World Markets Inc.
"It is costing banks more to get the money they lend to you. If they want to maintain profit margins, they have to transfer this extra cost to the consumer," Mr. Tal said.
The much harder-hit U.S. banks have already clamped down on their lending, which is contributing to an escalating rate of mortgage defaults. Moody's Economy.com estimates 10 million, or two-thirds, of shaky mortgage loans made from 2004 to 2007 will end up in default.
It's a global issue, with the housing markets in countries including Britain also devastated by a lack of available funds for mortgages. In England and Wales house prices declined by the most in at least eight years, according to British government data released yesterday. Last month, home sales transactions per agent fell to the lowest point ever recorded by the Royal Institution of Chartered Surveyors.
In Canada this week a number of banks raised mortgage rates, and it's a matter of days before others follow. The posted rate on the popular five-year fixed mortgage, for example, has gone up by 0.35 of a percentage point to 7.2 per cent.
With a discount, customers can get a rate of 5.85 per cent at Toronto-Dominion Bank, which is still a fairly low rate.
It should be much lower, however, when compared with the yield on government bonds, the market where banks finance their mortgage lending, Mr. Tal said.
"Before, it was automatic, the five-year bond rate went up five basis points, the five-year posted rate went up five basis points. [A basis point is 1/100th of a percentage point.] Now, five-year bond rates went down because the Bank of Canada was cutting rates, but the mortgage rate was sticky," he said.
Back in mid-December, 2006, when the Canadian housing boom was in full swing, the spread between posted five-year mortgage rates and bond yields was 2.59 percentage points, close to the average level over the past decade.
Today, as the credit crunch persists, the spread has widened by 56 per cent, to 4.05 percentage points as a result of tighter liquidity and economic volatility.
Executives at Canada's big banks say the industry will cut back on lending and raise rates as a result of the current environment.
In an interview this week, Tim Hockey, head of Canadian banking at Toronto-Dominion Bank, said that loan growth will slow in the industry.
"Clearly, one of the things that's happened as a result of the recent credit crisis is that the absolute cost of funds has gone up. And that has effects on both the price of lending, as well as on ... competition for deposits," he said.
The latest rise in borrowing costs for the Canadian banks stems from uncertainty about the $700-billion (U.S.) economic rescue plan. In the past week banks have been hoarding cash for fear the bailout could collapse.
As a result, the premium they pay for funds from other banks compared with the expected central bank rate has more than doubled.
"The increase is because of this instability, with no decision on this $700-billion bailout their costing is going up. They're passing it on to us, and the spreads have been increasing because of their costs," said Toronto mortgage broker John Panagakos.
Banks feel lending squeeze, and pass it on to consumer mortgages
Premium banks pay to borrow funds from other banks, compared with expected central bank rate
| Dec. 13, 2006 - Housing boom in full swing | |
| 5-yr fixed mortgage rate (posted) | 6.45% |
| 5-yr Canada govt. bond yield | 3.85% |
| Spread | 2.59 percentage points |
| Sept. 26, 2008 - Credit crunch in full swing | |
| 5-yr fixed mortgage rate (posted) | 7.2% |
| 5-yr Canada govt. bond yield | 3.15% |
| Spread | 4.05 percentage points |
SOURCE: BLOOMBERG FINANCIAL SERVICES
© The Globe and Mail
