Royal Bank of Canada will raise its special discounted mortgage rates by 10 to 15 basis points, effective Friday.Mark Blinch/Reuters
Canadian banks are seeing their lending costs rise – and they are starting to pass along those expenses to consumers.
Royal Bank of Canada announced plans this week to raise its special discounted mortgage rates by 10 to 15 basis points (there are 100 basis points in a percentage point), effective Friday. The changes are modest at this point. RBC left alone its prime rate and posted mortgage rates.
In some ways, these increases appear at odds with low rates elsewhere. Five-year bond yields, which tend to guide mortgage rates, have been tumbling over the past two months, and the Bank of Canada's key interest rate has remained unchanged, at 0.5 per cent, since July.
However, the banks are responding to what RateSpy calls an "inhospitable lending environment" that is being shaped by rising global financial risks, additional pressure on bank profits and tighter regulations.
Bank-issued preferred shares illustrate just how much this environment has been changing.
Toronto-Dominion Bank announced on Tuesday that it would issue $700-million of the debt-like financial instruments with a yield of 5.5 per cent. That's very high next to the Government of Canada five-year bond, which now yields less than 0.7 per cent yield.
What's more, the yield on the shares will remain attractive well into the future: The dividend rate will be reset in 2021 at 4.66 percentage points above the yield on the government five-year bond, a far wider spread than previous issues.
This is not an isolated case: RBC, Bank of Montreal and Bank of Nova Scotia have recently issued similarly enticing preferred shares to bolster their regulatory capital.
Put another way, the cost to the banks for issuing preferred shares has essentially doubled over the past year. That's because investors have demanded a greater reward to offset the risk of falling interest rates – which would lower reset yields – and the fact that newly issued preferred shares are non-viable contingent capital (NVCC): They convert to common shares if the bank nears failure.
"We think the pricing environment for these instruments has fundamentally shifted in Canada and will not recede to levels observed in the past," Peter Routledge, an analyst at National Bank Financial, said in a recent note. "As a result, the cost of financing, not just for preferred shares, but also other capital instruments such as subordinated debt and bail-in debt will similarly shift upward."
If the banks' funding costs are rising, the regulatory environment is also becoming more challenging.
In December, co-ordinated announcements from the federal Finance Minister, the Office of the Superintendent of Financial Institutions (OSFI) and Canada Mortgage and Housing Corp. were designed to cool housing markets in Toronto and Vancouver. In particular, OSFI's proposal could require banks to hold more capital against insured loans.
"The impact of these changes is intended to be small by design, but should at the margin put downward pressure on housing market activity and upward pressure on mortgage rates," Meny Grauman, an analyst at Cormark Securities Inc., said in a recent note.
But, in a relative sense, the banks have been fiddling with their mortgage rates for some time.
After the Bank of Canada cut its key rate by 25 basis points in January, 2015, the banks did not pass along the full cut to consumers: They lowered their prime rates by just 15 basis points. When the Bank of Canada cut by another 25 basis points in July, the banks again responded with a smaller reduction in their prime rates.
Even so, the margin the banks earn on loans has been falling, leading to concerns that an important source of profit growth is now sputtering.
David Berman