Market Commentary

Market Commentary - May 29, 2015


Monday was a non-event with markets closed in London and NYC and most Canadian fixed income traders (including yours truly) 'on course'. Tuesday saw a slew of second tier US reports on durable goods, new home sales, housing prices, and consumer confidence. Durable goods orders fell in line with expectations, but core shipments jumped for the second consecutive month. Consumer confidence was good, but not great. No Canadian data ahead of the BoC meeting on Wednesday. Yields fall about 5bps on the day and 5yr GoCs finish below 1.00% for the first time since end of April.

Focus on Wednesday was the BoC rate announcement and related statement. The bank delivered exactly what the market expected…no change in rates and comments that give the market no reason to alter views that rates are (probably) on hold for the rest of the year (unless they're not). To be honest, the statement had a real mix of positive and negative signals. At the margin, it might have left the market a little more dovish (less worried about inflation). Like the US, monetary policy for the balance of 2015 remains very data dependent, and central banks may swing from Dovish to Hawkish and back again before we're done. Yields fell another 4bps on the day.

GDP releases in Canada and the US had the markets full attention this morning. Canadian real GDP was overall weaker than expected, and will keep speculation about another rate cut alive. In the US, an already weak Q1 GDP number was revised down into negative territory. This revision, however, was expected and market reaction should be muted. Nonetheless, the uninspiring GDP news combined with continued uncertainties surrounding Greece, have put the market in a mood to buy (ie: take yields lower). Yields are down yet another 4bps this morning.

All told, the 5yr GoC benchmark (1.50% Mar 2020) yield is now 0.92%, about 13bps lower since we closed the books last Friday. The 10yr (2.25% Jun 2025) is at 1.63%, down about 14bps. CMB spreads are about half a basis point wider on the week but have outperformed weaker risk assets.

In mortgage insurance news, CMHC's market share is down to a record low 50% of new residential mortgages. CMHC CEO Evan Siddall said that after several years of cutting its share to reduce taxpayer risk to the mortgage market, the agency plans to hold on to the market share it has left. (For context, CMHC had about 90% share prior to the liquidity crisis). CMHC is now comfortably below the $600 billion insurance cap, and should have lots of room for new commercial multi-family lending going forward…in case you were worried about that.

Finally, if you happen to be in Nepal, happy Ganatantra Diwas Day! Enjoy the long weekend. 

Jason Ellis, Treasury Guy
Managing Director, Capital Markets

by First National Financial LP 29. May 2015 10:24

Financing Done Right

Client Objective: build two condo towers simultaneously

A long-standing First National client was transitioning from industrial to condo development and wanted to build two towers simultaneously. The first tower was 75 per cent sold, but the second was only 40 per cent sold, creating a challenge in securing financing.

The First National Solution: security-based financing

he client was looking to secure $18 million to fund the second tower. The First National team delivered this amount by creating a facility that leveraged security from six industrial buildings and five condo units within the client's existing portfolio.

The First National Approach: service, expertise, speed

The First National team applied ingenuity to create a facility that provided ample funds yet was easy to draw on. It took a deep level of understanding of the client and the investor to structure the right deal that made sense for both parties.


Check out the latest news, insights, and opportunities from First National Financial LP. https://www.linkedin.com/company/first-national-financial-lp

by First National Financial LP 26. May 2015 11:23

Event Report - Apartment Symposium

Developers, lenders, brokers, service providers, builders and more gathered to discuss the apartment and student housing markets and the burgeoning opportunities in new construction.

Andrew Drexler, Assistant Vice President of Commercial Financing at First National sat on a financing panel. He shares key insights by highlighting points he agreed with and where his opinions differed.

Agreed: new construction is definitely happening, but…

It is true that there is a lot of construction happening right now, but I’m not sure that the high-end market is as deep as it is perceived to be. In areas like Toronto, high rises are expensive to build so rents have to be high. I caution people to really understand their markets and be honest about whether the market is deep enough to support that supply.

A typical high rise takes two to three years to build, and most owners start leasing six months prior to project completion. In these scenarios, the lender and developer take on a lot of risk (it’s not like a condo, where pre-sales mitigate much of the risk). Every member of the panel agreed that a good sensitivity analysis is crucial. It’s important to understand what will happen to all stakeholders if interest rates and cap rates fluctuate.

Most developers are looking to borrow as much as they can. Construction loans are based on costs and the value of the building. So there is a strong sensitivity to the variables. Right now, when there is uncertainty about future rates, lenders are becoming more cautious about the parameters that make up valuations. Most are anticipating change and are preparing accordingly.

Disagreed: not everyone should build

The moderator was very passionate about the opportunities in Canada and was encouraging everyone to build, similar to what’s been done in the U.S. I have long disagreed with this view.

Not everyone qualifies for new apartment construction. In Toronto, I’m seeing a lot of people who think that they can retrofit failed condo sites for an apartment project. It’s a misguided approach. Here’s why:

  • Density: Land prices are driven by density. Construction costs are pretty constant whether you’re building an apartment or a condo. However, apartments have more restrictions on size in relation to value, yet the land price is still high. It can turn out to be a losing proposition.
  • The Starting Point: condo developers will pay for the land first, and work backwards to see how much revenue they can get. Successful apartment builders start with the market first and determine what it can sustain in terms of rent. They evaluate land purchase price based on market feasibility. Hard to do when you’re trying to retrofit an apartment construction to an existing condo site. 

Condo developers have had a lucrative decade. It’s been fairly easy for them to get financing, and they’ve been able to dictate terms to a certain extent. Investor syndicates is one trend that’s arisen from this climate. Different investors get together and show up as the guarantor on the loans. 

It’s a great model for condos, but it doesn’t translate to apartment construction loans. So for people trying to retrofit, it’s essential that they find more than just investors. They need experienced developers that have built and ran rental buildings.

Disagreed: student housing cap rates and valuations

There was one panelist who boasted about his student housing property in a great location, which was generating great rental income. We talked at length about aggregations on a per unit basis. This owner didn’t care about per unit value. He was only focused on total revenue.

I take issue with that. Any real estate trades on cap rates (net operating income divided by purchase price = rate of return pre-debt). Cap rates have come down significantly across all asset classes because debt is readily available and cheap. In student housing in particular, cap rates have come down significantly, but the cost of debt for student rentals hasn’t come down in the same way that it has for apartment buildings.

The panelist/owner justified his position by saying that his “big rents” offset the low cap rates. However, I still feel that valuations for student housing are too aggressive. They need to come down because the financing environment isn’t as favourable, with respect to LTV and interest rates, as it is for apartment buildings. 

Balance returns with realities

There is no disputing that new apartment construction will deliver favourable returns during the next decade. But I can’t stress enough how important it is to balance potential returns with the realities of building an apartment from the ground up.

Understanding your strengths as well as your limitations is critical to maximizing the power of the right project. The right partners – developers, lenders, suppliers – can give you a greater or optimal level of expertise that you may not be able to cultivate on your own. 

by First National Financial LP 12. May 2015 12:57

Market Commentary - March 4, 2015

Good Afternoon. At 10:00 this morning the Bank of Canada announced that it was leaving the overnight target rate unchanged at 0.75%. This was largely the expected outcome, however, the policy statement was decidedly less 'dovish' than expected. The bank cited balanced risks around inflation and financial stability suggesting no bias for policy ahead. In fact, rather than less 'dovish', one might even say the statement was more 'hawkish'. The bank went on to say that the "anticipated rotation into stronger growth in non-energy exports and investment is well underway" and the prevailing conditions since the January rate cut should "mitigate the negative effects of the oil price shock".

Bonds predictably sold off on the news and yields are up about 10bps across the curve on the day. 5 and 10yr GoC benchmarks now yielding 0.92% and 1.51% respectively. Since the close last Friday, yields are about 20 basis points higher.

The implied probability of a cut at the April 15th meeting has fallen to about 20%. In fact, some economists are now discussing the possibility of a "one and done" scenario and are suggesting no future rate cuts at all. Time will tell.

Jason Ellis
Managing Director, Capital Markets

by First National Financial LP 4. March 2015 13:25

January 23, 2015

Good morning. Apologies for the lateness of today's posting, but I've only just returned from a Financial Services Regulatory Conference. Good times. I really only go for the free danishes.

Anyway, a couple of important updates since the Bank of Canada's shocking decision to drop rates.

First, as you probably have noticed by now, the big banks have not followed the BoC lead and have left Prime rates unchanged at 3.00%. An article in Bloomberg suggested that the failure by the banks to reduce Prime would 'raise the ire of the Bank of Canada since the rate decline would not flow through into consumer lending rates. In truth, I bet this is EXACTLY what the BoC wanted. I don't imagine this rate cut was intended to make mortgages, car loans, or lines of credit any cheaper. It has, however, had the desired effect on the Canadian dollar which will be supportive of manufacturing and exports.

The good news for our commercial borrowers is that your insured construction or adjustable rate mortgage is based on our Asset Backed Commercial Paper cost of funds, which is closely tied to BA's, which did fall about 25bps in sympathy with the BoC rate. It will take a couple of months for the decrease to filter through as older paper matures and new paper is issued at prevailing rates, but our insured floating rate cost of funds will reflect the change in rates.

Second, in the press conference that followed, Governor Poloz noted that the Bank could take out more insurance in the form of another rate cut should the outlook deteriorate further. The key wildcard remains the price of oil. It is now very possible that the bank will follow through with another 25bps rate cut as early as March before moving to the sidelines.

Oh right. One more thing. Super Mario and the ECB announced its Quantitative Easing (QE) program. Too early to really say how this impacts our world, but it certainly adds a new dynamic to the markets.

Bond yields have been range bound the last couple of days and continue to trade around the levels they plummeted to on Wednesday. I'll try my best to keep you posted but hold on tight in the meantime, because it's going to be a *&%$* bumpy ride!

Jason Ellis
Managing Director, Capital Markets

by First National Financial LP 25. January 2015 19:47

Market Commentary - January 21, 2015

Bank of Canada cuts the overnight rate from 1.00% to 0.75%.

Responding to concerns about the impact of cheaper oil on growth and inflation prospects, the Bank of Canada cut its overnight target by 25bps to 0.75% this morning. The last change in the overnight rate was in September 2010 when the rate moved up from 0.75% to 1.00%.

The surprisingly dovish statement stresses the downside risks to both the inflation profile and financial stability from energy market developments. This surprise move (none of the surveyed economists anticipated this) is intended to provided insurance against these risks. Obviously, very negative for the C$ and very positive for fixed income. CAD now trading at 1.2358 vs the US dollar (up 2.5 cents). The curve has steepened this morning with 2 year bond yields down 26pbs, 5 year bonds yields down 19bps and 10 year bond yields down 5bps.

All of this, of course is against the backdrop of a very challenging credit environment and changes in sovereign bond rates will not necessarily translate into cheap credit. Still no word on Prime rate, but the last time the Bank of Canada cut rates by 75bps in 2008, the banks only lowered Prime by 50bps, taking the Prime-Bank Rate basis from 1.75% to 2.00%. We'll have to wait and see what the banks do, but I expect Prime will be reduced to 2.75%. I expect fixed mortgage rates and other consumer lending rates to be more sticky though. (Bank stocks are up sharply, by the way).

Commercial mortgage spreads have been trending up over the last 30 days from a low in the fourth quarter of 2014 at approximately 160 – 170 basis points over Canada's to 190 to 200 over Canada's for 5 year product. 10 year spreads have moved in a similar fashion to 210 to 220 basis points over Canada's. This is consistent with increases in other credit products such as corporate bonds and bank deposit notes. For example, First Capital Realty Inc. issued a 10 year unsecured debenture yesterday at a spread equivalent of 213 over Canada's. We would expect to see floor rates used by most lenders to protect their all in coupons from further bond spread compression.

Jason Ellis
Managing Director, Capital Markets
First National Financial LP

by First National Financial LP 21. January 2015 21:32

Financing a 50% vacant building

Financing done right - a case study 

Client Objective: building purchase and renovation
A long-standing First National client that was looking to build its portfolio in a specific geography purchased a building that was 50 per cent vacant, with the goal of renovating it and increasing its value.

The First National Solution: interim financing and CMHC loan
First National provided a loan that was 85 per cent of the acquisition price right away and allowed the financing necessary to enable the renovation as well. Once the renovation was complete and the building was full, First National secured a CMHC loan within 8 months of acquisition.

The First National Approach: obstacles as opportunities
Considered high risk by most lenders because of the vacancy rate, First National never questioned the viability of deal. Having done deals similar to this one with the client, the First National team knew that First National’s ability to take smart risks, ingenuity and nimbleness and the client’s real estate legacy combined would make the deal quick and straightforward

by First National Financial LP 21. January 2015 10:42

Janaury 16, 2015

Where to begin?  I’m not sure I have the words.  Bond yields in Canada reached record lows (again) on Thursday afternoon as investors fled to the safety of fixed income amid tumbling commodity and stock prices and signs of poor global growth.  Bond yields fell a full 10 basis points on Thursday alone, and are close  to 25 basis points lower since this time last week.  Why the big rally in bonds yesterday?  There are a lot of reasons, but we can sum it up in two words…”The Swiss”.   The Swiss National Bank roiled markets worldwide with its surprise decision to abandon the Franc’s cap against the Euro.  SNB also lowered its already negative deposit rate from -0.25% to -0.75%.  Despite the drop in deposit rates, the Franc appreciated 23% against the Euro on the day.  Sadly, that Rolex you’ve had your eye just got a lot more expensive…

In other upbeat news, a real estate research piece from Deutsche Bank  that has been making the rounds highlights Canada as the most overvalued real estate market in the world.  According the analysis, our housing market is more the 60% above fair value.  No doubt the German analyst who wrote the piece felt a warm, comforting sense of schadenfreude.  If you didn’t already know, schadenfreude is uniquely German word to describe the pleasure derived from another person’s misfortune.   

Lastly, back on Monday the Bank of Canada Business Outlook Survey (or BOCBOS for fun) showed that business sales optimism fell to its lowest level since 2012.  Then, on Tuesday, Bank of Canada deputy governor Timothy Lane said that lower oil prices are likely to be bad for Canada (duh) and may delay the economy’s return to its production potential.  Any gains from lower prices for consumers will be more than reversed over time as lower incomes from oil spill over to the rest of the economy.   Oh yeah, and Target and Sony are packing up and leaving Canada.  In fact, the sell orders are piling up on Canada as Bank of America and Fidelity Investments are publicly betting against the currency, equities and even (gasp) our bank stocks as oil continues its plunge.  

All that AND the Leafs are now firmly out of the playoff picture.  At least it’s Friday.

Up to the minute update: U.S consumer prices recorded their biggest decline in six years this morning, which could bolster the case for delaying the first interest rate increase from the Federal Reserve.  CPI fell 0.4%.  While Fed officials view the energy-driven inflation weakness as transitory, darkening prospects for the global economy and a strong dollar will complicate matters for the U.S. central bank. 

by First National Financial LP 16. January 2015 09:58

January 9, 2015

Happy New Year.  After an extended break and two rounds of antibiotics, we’re back.

It’s been a roller coaster ride between my last post and today, but that’s history,  so let’s skip forward to what happened this morning with US and Canadian employment data.   Canada’s numbers were quite soft with net change in employment down 4,300, but the details are generally better than the headline would suggest with full time jobs actually up 54,000.  US Payroll figures were stronger than expected with a headline gain of 252,000 jobs and a strong revision upward of last month’s number.  The bond market is still making up its mind this morning, and for the first time in a while, rates are actually relatively unchanged in early trading.  The 5 and 10yr GoC benchmarks (Sep 2019 and Jun 2024) are trading around 1.25% and 1.70% respectively (or about 15bps lower than my last post on December 18th).  If you need context, I would describe those are as VERY low rates.  Not as low as rates in Germany though.  The 5yr Bundesobligationen currently trades just at touch under 0%.  Not a great return for the investor, but at least you get to say ‘Bundesobligationen’.  If that wasn’t enough fun, if you’re willing to accept a rate of -0.10%, you could own the 2yr Bundesschatzanweisungen. 

Good Luck in 2015.

by First National Financial LP 9. January 2015 13:47

December 19, 2014

Global stock markets surged on Thursday with the S&P500 headed for its best two-day rally in nearly two years as the Federal Reserve pledged patience on boosting rates. As usual, a 'dovish' Fed is making up for a lot of bad news from Europe and other parts of the world. Of course, beyond the next 'couple' of meetings, Fed Chair Yellen made it clear that the potential for a hike in rates was in place. In response, bond prices out the curve, in contrary to equities, fell sharply on heightened expectations that borrowing costs will rise next year. But that's next year, so don't worry, be happy….Canadian bond markets reacted to the FOMC news in a derivative kind of way and lagged the move in Treasuries. 5yr GoC's are 10bps higher than the close on Tuesday, but 5yr Treasuries are up 16bps. (Plus your RRSP account will look much better today than it did on Tuesday).

Of course, as low as rates are in Canada, borrowers can be envious of their Swiss peers. The Swiss National Bank surprised markets on Thursday by introducing negative interest rates. Deposit your hard earned savings for a year, and get back $99.25 for every $100 invested. On the plus side, you get a giant novelty Toblerone bar when you withdraw your money, so that's nice. Of course, the negative rates are in place to discourage safe haven buying of short term deposits by anxious investors in Russia. Sadly, calls to SNB to borrow money at negative rates have not been returned.

And lastly, in the category of 'that just isn't right', a Liter of carbonated water (a.k.a Perrier) now costs ELEVEN times more than a Liter of West Texas Intermediate.

Merry Christmas, Happy Hanukah, and best wishes for a healthy, happy and prosperous new year. I'm off to practice my Feats of Strength for Festivus now. Treasury out!

by First National Financial LP 19. December 2014 13:51