Even as the Bank of Canada continues to raise interest rates, more customers at Bank of Montreal are choosing variable-rate mortgages as they begin to feel the pinch of higher borrowing costs.
Although most Canadians continue to opt for fixed-rate mortgages, seeking certainty in a changing rate environment, interest charged on variable loans can still be as much as one full percentage point lower. Of late, a growing number of BMO’s customers have been betting that rates will rise slowly enough that it will cost less to choose a variable option with a lower monthly payment for another year or two.
That strategy could become more risky for borrowers as Canada’s central bank adopts a more hawkish tone, leaving its previous messages about taking a “gradual” and “cautious” approach to interest rate hikes out of its most recent statement. The prospect of more-rapid rate increases is generally expected to be good news for lenders, however, promising more robust profit margins on many loans even as banks watch closely for signs of strain on highly indebted consumers.
“There’s been some move to more variable [rate mortgages],” Cam Fowler, BMO’s president of North American personal and business banking, said in an interview. For the most part, those clients are drawn to a “shorter term," he said.
The impact of the shift is financially “immaterial" to the bank at this point, Mr. Fowler said. But BMO has been competing aggressively with Toronto-Dominion Bank on variable-mortgage pricing, offering an incentive for customers to put off locking in their rates.
The bank is also tracking the broader impact of the Bank of Canada’s decisions. “There isn’t going to be particularly near-term pressure on people’s ability to service [debt],” Mr. Fowler said. “Will it be a contributor to continued moderation on the purchase side? Perhaps. But my hope or expectation is it’s moderation in terms of buying decisions, as in people being thoughtful about what they can afford."
All six of Canada’s largest banks raised their prime rates to 3.95 per cent on Wednesday from 3.7 per cent. That should help expand profit margins that were squeezed during the long period of ultralow interest rates after the 2008 financial crisis, as banks typically raise the interest they charge on loans faster than the rates they pay on deposits.
“The rising rate environment has been good for our bank, it’s been good for most banks,” Darryl White, BMO’s chief executive officer, said at an investor day the bank held on Wednesday.
BMO also has about $135-billion it invests in bonds that should gradually mature and be replaced at higher rates over the next five or six years, providing stronger investment returns, according to chief financial officer Tom Flynn. “Over time, that can be very significant and will provide, we think, a real tailwind to our revenue," he said.
The prospect of more rapid rate increases is bound to raise concerns among investors that some consumers will start to feel strained by high household debt levels, which could eventually push banks' loan losses higher.
Canadian bank stocks performed poorly on the Toronto Stock Exchange on Wednesday amid a broader market decline, with share prices retreating anywhere from 1.66 per cent at TD to 3.9 per cent at Royal Bank of Canada.
But Mr. White noted that Canada’s rate of increase in household consumer debt has moderated over the past year, and even been eclipsed by increases in disposable income. “We’re at a place of confidence in the Canadian economy,” he said. “So the Bank of Canada’s actions are appropriate, in my view, and they really shouldn’t be a big surprise.”