February 13, 2013 Comments

Today we had a number of stocks falling in price. But that is nothing unusual.

Boston Pizza was up 2.5% to $20.40. It just released earnings last week which at a quick glance were pretty good. I’ve toyed with the idea of selling some of what I have (It’s in RRSP so no capital gains tax to worry about). But then again I see no reason for it not to hold up pretty decently and so I just hold it. (Of course it always COULD fall).  When it was at $14 about 16 months ago I never expected it to jump so fast or to anything close to this $20. From here I really see also no reason for it to increase much if at all. The yield already seems a bit low for an entity that will not grow dividends per unit fast at all (for the reasons indicated in the report). Longer term if interest ever finally rise its yield will rise meaning the price would drop.

With Canadian Tire down, I bought a bit more. This may in fact be sheer stubbornness on my part. The stock just looks cheap to me. If in fact earnings do stumble than I am hoping for some kind of action like a change of management to release value. I think the value is there (in the credit card portfolio, and the real estate in addition to the actual retail business)  so that provides some downside protection. But hopefully earnings do not in fact stumble. In December the company started buying back its own shares for the first time in a while (outside of smaller buys to offset stock option grants). They did not buy any since year-end but often companies are not allowed to buy shares between the end of a quarter and when they release earnings. The share buy back gave me some hope that management as of December saw the stock as cheap and therefore were not likely expecting to report bad news. We shall see around February 21 when they report earnings. But even if earnings are good, the market may not push the stock up until and unless the company proves it can maintain earnings after Target gets in operation.

Mortgage rates:

About 14 months ago I did a lot of digging into why Americans can lock in mortgages for 30 years (30 years!) at really low rates while in Canada the normal maximum lock-in was five years, although seven and ten years were available at rather exorbitant interest rate premiums. A 25 year lock in was available at a huge premium. I never did get any satisfactory answer to the mystery.

The interest rates I saw at that time were:

5-year fixed 5.29% but 4.09% special deal (so similar to U.S. 30-year fixed rate)

10-year fixed 6.75% but 5.45% special deal (39% higher than U.S. 30-year fixed)

25-year fixed 8.75% (call for special deal) I called and the mortgage specialist was not aware what the special deal might be and had never heard of anyone locking in for 30 years. The posted rate is more than double the U.S. 30-year fixed rate.

Well some things have changed.

Today a number of banks are offering very competitive 10 year locked in mortgage rates:

Scotia Bank has the lowest at 3.69% locked in for 10 years.

For the Canadian market, that is phenomenally low. Many people with large mortgages who cannot afford it if rates rise should consider locking in. The lowest posted rates are around 2.4% locked in for one year. So it is tempting to take that lower rate.

Maybe you can get even lower than 2.4% through a mortgage broker. But there are certainly people who might want to consider that 10-year lock-in.

Interest rates have gone lower than almost anyone thought they could and they have stayed low. But things can happen fast in the finance markets. Rates can rise. Rate are at record lows and they will rise at some point.

At 3.69% I almost tempted to take a few hundred thousand out as a mortgage and invest that. I would be very surprised if I could not make more than that 3.69% on average over the the next ten years by investing. But in the end, I don’t need the stress. Markets can fall and one way to add a lot of stress to your life is to be in the markets with borrowed money during a major market decline.

I suspect banks are able to do this because they have in turn found investors willing to lend money to the bank for ten years at something like 2.5%. If they can securitize these mortgages and fund them from investors locked in at say 2.5% then that is okay for the banks. (A 1.19% spread for the banks is not great but not horrible). 10-year Canada bonds pay investors 2.0% so I can’t see any sane investor offering ten year money to the banks at less than about 2.5%.)  If on  the other hand the banks are funding these mortgages with non-locked in deposits (on which they pay approximately nothing) then the banks are playing a very dangerous game. Higher spreads now but massive risk if deposit rates rise in the market.

Then there are the American banks who manage to offer 30-years locked in at 3.5%. The 30-year treasury in the U.S. pays 3.23%. So we have homeowners somehow borrowing at nearly the same low rate as the U,S, government. This is only possible due to a phenomena that I would call “stupid investor tricks”. In order for a bank to lend at 3.5% for 30 years it needs someone (investors) willing to lend it money at less than that. (And, no, despite what you heard about fractional reserve banking, they don’t get to print up the money in the basement of the bank)

Part of the game here is that mortgage investors expect a lot of the mortgages to be paid out early and so they don’t expect their money to really be tied up for the full 30 years. These investors will be sorry if rates rise, as their money will be locked up for a long time at low rates.

Warren Buffett has advised that it is wise idea for American’s to buy houses and to lock in at these ultra low 30-year rates. What is smart for the borrower will not ultimately be smart for the investor who funds that mortgage . (The banks tend to be in the middle hopefully collecting a spread and fees and not taking the risk).

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