INTEREST RATE TRENDS - JANUARY 7, 2008 2007 in Review
It is always interesting to look back at past predictions to see how they turned out and as we reviewed our comments from April 2007, we were reminded that forecasters universally predicted that bonds would increase in the last quarter of 2007, the result of anticipated economic growth. Further increases were anticipated to continue throughout 2008. We cautioned our clients to be aware 2007 Rate Projections of “near term rising interest rates”, suggesting that 30 day BA’s would 4.70 4.55 move down from 4.35% in April, to th 4.50 finish at 4% in the 4 quarter, before 4.35 moving up in the 1st quarter of 2008 4.50 4.30 to 4.5%. Long Bonds were predicted 4.10 to stay relatively flat, declining by 10 4.10 4.20 bps during 2007 before moving up 3.90 from 4.2% in April to 4.1% in 4.00 December, but then moving up 3.70 45 bps to 4.55% by the 2nd quarter of 2008. Overall, our outlook rates in 3.50 2007 was very positive; a flat yield Apr-07 Q2/07 Q3/07 Q4/07 Q1/08 Q2/08 curve; nominal rate fluctuation; an 30 Day BA 10 Yr Bond abundance of capital generating very tight spreads for both conventional and CMHC Insured transactions…Life was Good.
2007 Actual
Focusing in April 2007, on the long-term 10-year bond, the calm interest rate environment quickly disappeared, 2007 10 Year Bond - Actual vs. with a 71 bps increase to 4.71%, from April to June 2007. However, Projected our concerns about bond rates 4.90 escalating into 2008 began to 4.71 4.70 ease, as the 10 year bond rate 4.55 4.50 began to fall from its peak, moving to 4.35% in November, finishing, 4.30 as expected at 4% in December.
4.10
4.00 However, borrowers were far from 3.90 pleased as they were introduced to 3.78 3.70 a new component of lenders’ calculation of risk spread 3.50 requirement, generally known as Apr-07 Q2/07 Q3/07 Q4/07 Q1/08 Q2/08 the “US sub prime housing Projected Actual market”. Years of excess liquidity and “nominal” credit spreads finally gave way to a massive reprising of risk, which began in the 3rd quarter, continued in the 4th. It is increasingly evident that the issues relating to the US housing market and related credit market will take sometime to be resolved.
In the 4th quarter, numerous banks announced massive write-downs because of their exposure to the US sub prime housing market ($76 Billion wrote off in 2007). 2008 has started with further write off announcements and we expect that it is far from over, based on another $400 Billion in mortgage maturities due to be reset in 2008. Just how deep this will impact the global market and particularly Canada, remains uncertain. Investors (Institutions) have chosen to either move to relatively safe investment havens (T-Bills), which has limited credit availability for mortgage investments, resulting in an increased risk premium and higher consumer rates. The fall out of this market CM HC 2007 - Insured 10 Year Bond turmoil is shown in the two 6.00 graphs, which indicates an increase in lender spread 5.50 5.31 5.20 requirements from historical averages for CMHC required 4.78 5.00 60 BPS mortgage transactions of 60 bps, increasing to 80 bps 80 BPS 4.50 through the summer and more 100 BPS 4.73 recently in the fall to the end of 4.35 4.00 2008. Further increases are expected to as much as 100 3.78 200 bps. Notwithstanding 3.50 increasing leaders spreads however, as a result of a declining bond market, effective rates to borrowers have Bond Rate Gr os s Rate remained relatively constant at around 4.80 – 4.85 since November and as of date of writing in January the effective rate to the borrower is 4.78%.
20 07
A similar experience is indicated in the Conventional lending world where typical lender spread requirements moved from 140 bps up to 180 bps by October and finishing the year with a spread requirement of 200 bps and perhaps more depending on the risk profile of any particular asset class. Notwithstanding, effective rates to borrowers have declined from rates early in the year of around 6%, tracking around 5.8% through the fall, with indicative rates of 5.8% available at the time of writing of this article. We must caution readers, however, that
Sp rin g
2007- Conventional 10 Year Bond
Se pt em
6.00 5.50 5.00 4.50 4.00 3.50
6.11
140 BPS
er N ov em be r D ec em be r Ja nu ar y08
m er
be r
Su m
O ct ob
6.15
180 BPS 200 BPS
5.78
4.71
4.37 3.78
m m er
r
Oc to be r
20 07
Sp
Bond Rate
No ve m be r De ce m be r Ja nu ar y08
rin g
Su
Se
pt em be
Gross Rate
depending on your asset class, effective rates to borrowers may be higher or lower and are very much subject to risk yield requirements of the lenders.
2008 Projections Short Term Rates
As a result, it is widely anticipated that the Bank of Canada will follow the December 25 bps cut to 4.25%, with a further 25 bps cut to 4% in January, with “economic justification for additional rate cuts…remaining soft through 2008”. It is expected that 3 month treasuries will trend up by almost 50 bps from 3.7% in the first 2008 - Bond Rate Projections quarter of 2008 up to 4.15% by Q4/08, providing a more appropriate 155 - 160 bps Prime to 4.60 BA spread. 4.50
Long Term Bonds
Based on the sub prime mortgage 4.00 maturity reset schedule, it is anticipated that credit issues should ease during the second half 3. 70 of 2008. As a result, long bonds will track the short-term market, 3.50 with 10-year bonds expected to Q1/08 Q2/08 Q3/08 Q4/08 move up from their current level of 4% to 4.6% by the end of the year. 3 Mos. T-Bill 10 Yr Bond Interestingly, the differential between 10-year and 30-year term bond yields projected to be very tight, particularly in the second half of the year.
4.00 4.15
The following is our interpretative interest rate forecast for 2008. INTEREST RATE FORECAST
Jan. 21/08 30 Day BA 3 Mos. T-Bill 5 Yr Bond 10 Yr Bond 30 Yr Bond Q1 / 08 Q2 / 08 Q3 / 08 Q4 / 08
4.18
3.70
3.90
3.95
4.15
3.44
3.75
3.85
4.20
4.40
3.74
4.00
4.15
4.50
4.60
4.07
4.10
4.30
4.50
4.60
The Bottom Line
The impact of the US sub prime housing market is a global phenomenon and the impact on credit availability and pricing will not be sorted out until the second half of 2008. The reality is that until the magnitude of the losses to be incurred is known with greater certainty, lenders reluctance to fund mortgage transactions will continue to be reflected in their pricing structure and will be a major impediment to delivering quality capital solutions. While lack of institutional investors / lenders will directly impact spread requirements and therefore gross rates to borrowers, of much greater concern for borrowers may well be the absence of quality capital for certain asset categories. Fortunately, our clients can take comfort in the knowledge that: 1. Our committed capital relationships continue to support are applications but the credit process is and will continue to be, a far more intensive exercise, with credit departments requiring more and more comfort in support of their final sign off. 2. Even with increasing yield requirements, effective interest rates to borrowers are projected to remain in the 5.5% – 6.5% range for CMHC and Conventional applications respectively. The role of IC Funding remains unchanged, providing quality capital solutions for our borrower clients and ultimately delivering “ the right deal … every time.”