Market Commentary

Market Commentary - November 27, 2015

Good Morning,

I’m back from vacation.  Nothing like Scotland in November.  Anyway, let’s spend a minute catching up.  When I last wrote on 13th, 5-year benchmark Canada bonds were trading just under 1.00% but have drifted down to 0.90% since then.  The largest single day move was back on Friday the 13th, which proved unlucky for US data watchers.  Bonds rallied and yields fell around 6bps as Retail sales and producer prices both missed consensus expectations bolstering the case for a more Dovish (less likely to move rates up).  Nonetheless, odds of a Fed hike in December still stand around 67%.  As far as the Bank of Canada is concerned, markets have nothing priced in for the next 4 meetings.

In securitization news, Canada Housing Trust issued $2 billion 5yr Floating Rate and $2 billion 10yr Fixed Rate bonds last week.  The deals cleared, but the floating rate note didn’t exactly fly off the shelves.  While the size of the deals was consistent with previous issues, the allocation of funding to the participating mortgage lenders was the lowest ever, suggesting more lenders participating in the program for an ever smaller slice of funding.  In more positive news, Bank of America Merrill Lynch tested the residential NHA MBS market earlier this week and successfully issued $400 million after upsizing the deal from $300 million.  The issue was priced 6bps narrower than the last syndicated MBS which was issued by Equitable Bank in September.  In fact, this is the first time a syndicated MBS pool has priced tighter than the previous issue since January 2014.  Let’s hope this is the start of a new trend.

Today should be quiet.  Nothing of significance on the economic calendar and the US is in virtual holiday mode as people sleep off their Thanksgiving hangovers and line up for Black Friday sales.  As for me, I’m too old and lazy to chase a discount.  I’d rather pay full price and watch the fist-fights over the last toaster oven on TV.  If you are out there looking for a bargain today, please remember your manners.  If someone has been trampled, gently reach over them to get the last GI Joe with the Kung-Fu Grip.

Be careful out there,

Treasury Guy

Jason Ellis
Managing Director, Capital Markets

by First National Financial LP 27. November 2015 09:53

Market Commentary - November 13, 2015


Not a lot to talk about really.  The afterglow of Friday’s employment induced sell-off has faded and with a relatively light data calendar and a bank holiday on Wednesday, we had a very quiet trading week.  Yields are down 4-5bps from the frenzied trading last Friday. 

Overall, market tone with respect to credit spreads and liquidity remains constructive but cautious.  Investors are starting to dip a toe in the market and as one Debt Capital Markets professional put it, “the ducks are quacking”.   That’s encouraging, but personally, I’m not buying any bread crumbs yet.

Keeping the positive vibe going, Canadian Consumer Confidence on Monday reached a one year high of 58.3 according the poll conducted by Nanos Research.   The one year average is 55.5.  The results are considered accurate within 3.1 percentage points 19 times out of 20.  So, statistically, I’m not sure we’re actually any more confident than average, but we’ll call it a win. 

Speaking of Canadian confidence, we haven’t mentioned Oil for a while.  After bottoming out at $38 in August, Oil has had trouble staying above $45, and is currently trading around $42/barrel.  For what it’s worth, a ‘Barrel’ of Fiji Water would cost you over $500.  I wonder what it would cost to fill a Barrel with Kraft Dinner. 

Overnight Index Swaps tell us that the Bank of Canada will leave rates unchanged at each of the December 2nd, January 20th and March 9th meetings.  Fed Fund Futures suggest a 66% chance of a hike by the Fed on December 16th.  Expect ‘Fedspeak’ in coming weeks to slowly push that closer to 100% and remove any chance of a market surprise.

That’s about it.  It’s Thursday night now.  US Retail Sales and PPI data are due out tomorrow but I don’t imagine either will overcome the inertia of a Friday morning.  Should be range bound for now. 

As for me, I’m off to Scotland tomorrow for Haggis, Neeps, and plenty of Scotch, so no commentary next week.  You’ll have to read the newspaper or talk to your helpful First National representative.  Remember...borrow early and borrow often (but please borrow responsibly).

Lang may yer lum reek.

Treasury Guy

Jason Ellis

Managing Director, Capital Markets

by First National Financial LP 13. November 2015 10:19

Market Commentary - November 6, 2015


Hedge ‘em if you got ‘em!  Yields are up.

Markets were fixated on employment reports on both sides of the border this morning, and they didn’t disappoint.  Net Change in Employment in Canada came in at 44.4K relative to 10.0K expected.  Of note, however, is the temporary influence of election related hiring.  Still a strong result though.  In the US, change in Non-Farm Payrolls was 271K relative to 185K expected. 

Bond prices are sharply lower as a result and the 5yr GoC benchmark is back above 1.00% for the first time since June 30th.  The 5yr is currently trading at 1.03% compared to 0.76% just 8 trading days ago.

For those of you who prefer longer terms, the 10yr GoC benchmark is back above 1.70% for the first time since the beginning of July, trading at 1.71% compared to 1.42% just 8 trading days ago.

What does this mean for the future of monetary policy in Canada?  Interest futures had implied no chance of another ease by the BoC at the December or January meeting and today’s data shouldn’t change that.

Of course, the opposite will be true for the Fed.  Today’s pickup in employment will give credence to Fed Chair Janet Yellen’s comment that improving economic data would make a December rate increase a “live possibility”.  After today’s data, I’d suggest it’s game on for the Fed on December 16th.

In Canada Mortgage Bond news, we’re expecting a $2 billion re-opening of the 10-year December 2025 and a new floating rate issue due March 2021 to be launched the week of November 16th.

In terms of spread, the 10yr CMB is trading 15bps tighter than early October but is still a couple bps wider than where the issue was priced mid-August.  In a broader measure of credit spreads, the US CDX Investment Grade Index has fallen from 94 on October 1st to 78 today, suggesting an improved tone in credit markets.  Nonetheless, that elusive warm blanket of “liquidity”, real or imagined, is still top of investor’s minds.

Lastly, an important fact from the Kraft-Heinz company.  Heinz sells more single-serve ketchup packets annually than there are people on earth…about 11 billion/year.  Madness.

Have a great weekend,

Jason Ellis

Managing Director, Capital Markets

by First National Financial LP 6. November 2015 12:10

Understanding the importance of cash flow

How certain lenders determine value

Brian Kimmel, Assistant VP of Commercial financing, sees it all the time. A prospective client will approach him looking for financing on what the client thinks is a valuable property. Kimmel does a cash flow analysis and delivers news that’s often shocking. From a cash flow perspective, the building isn’t worth what the borrower thinks.

In Kimmel’s view, cash flow is a fairly misunderstood concept, especially among novice or unsophisticated investors

“First National is a cash flow lender,” says Kimmel. “For a cash flow lender, the revenue a property is able to generate always outweighs the asset value. Our main concern is mortgage serviceability.”

The cash flow conundrum

Kimmel often uses an illustration to help prospective clients understand the cash flow conundrum.

A client is buying an office building for $10 million. The building has some vacancy and several other pressing issues. The client is looking to secure $7.5 million in financing (75 per cent loan to value) and is investing an additional $2.5 million of his own money.

To the borrower, it’s pretty cut and dry. The building is worth $10 million. Asset value is high, so financing should be a breeze. 

It’s here that Kimmel usually interjects and sets the client straight. The building may be worth $10 million, but does it have enough cash flow to service the $7.5 million loan?

“I find that some borrowers are unfamiliar with the factors contributing to cash flow issues,” says Kimmel. “It can be any number of things from vacancy and abnormally high expenses to inflated purchase cost and building mismanagement.”

Cash flow is Kimmel’s biggest concern. If the building can’t service the mortgage in question, its market worth is inconsequential from a financing perspective.

For Kimmel, a key part of his role as trusted advisor is to help clients manage challenges such as cash flow shortfalls. He recommends three ways that borrowers can bridge the cash flow shortfall including:

  • Investing additional equity until the cash flow situation improves
  • Providing collateral security on other properties
  • Securing secondary debt that may be higher in price but requires less cash flow coverage 

A surprising answer for one borrower

A novice investor was looking to purchase a six-plex in a highly desirable neighbourhood in Toronto. Based on the value of the area, buildings are pricey, sometimes going for close to $500,000 per unit.

However, rents can only go as high as the market will bear. For this specific area, one-bedroom units were only fetching $1500 per month. Based on a cash flow analysis, unit worth was closer to $200,000, rather than the asset value projection of $500,000.

As a result, Kimmel was only able to offer a 30 per cent loan to value on a traditional financing basis. The building’s cash flow could only service a mortgage of $150,000 per unit. While the asset value of the property was high, the cash flow was insufficient to support the type of financing that the borrower was seeking.

“Newer real estate investors need to crunch the numbers realistically and understand how important cash flow is to a lender like First National. It can be the best building in the world, but if there isn’t positive cash flow, it may not be a fit with our mandate. If the borrower is open to being inventive, we can work together to get the deal done,” says Kimmel. 

Connect with Brian on LinkedIn or via email at brian.kimmel@firstnational.ca.

Follow First National Commercial Financing

by First National Financial LP 3. November 2015 08:46

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