At First National, we ensure the competitiveness of our rates by leveraging the Canada Mortgage Bond (CMB), the most competitive source of funding for CMHC-insured, multi-family mortgages.
Our goal is to consistently manage our risk premium as it relates to mortgage yields. As a result, we focus on precision when hedging our funding/interest rate risk. Some lenders choose to quote mortgage spreads relative to Government of Canada Bonds (GoC), yet this approach exposes lenders to changes to the five-year GoC and the five-year CMB. Commonly referred to as basis risk, this scenario inhibits how aggressively a lender can quote spreads.
We choose to quote as spreads over the CMB, which enables us to draw a direct link between our pricing/hedging reference and the actual cost of funding at the time of securitization.
Even when leveraging an effective hedging vehicle, there are risks and costs associated with being too hasty in locking rates for borrowers. The risk is amplified when the subject mortgage will be funded with a CMB maturity that hasn’t been issued. In this case, hedging relies on the closest available CMB, exposing the lender to basis risk.
The why behind CMB
When using CMB, the pricing is referenced, and we quote the borrower interests rates as spreads over the CMB. That way we can pass along the most competitive rate possible by virtue of minimizing the associated hedge risk.
Less knowledgeable borrowers sometimes complain that CMB is confusing as a reference rate. However, the transparency is similar to that of the Government of Canada Bond (which other lender institutions leverage). Regardless of the borrower’s familiarity or comfort with CMB, we see the value in being able to provide the most aggressive rates by limiting the hedge risk.