In the last 12 days, big banks have launched a Blitzkrieg offensive on the competition.

• They initiated unusually aggressive rate promotions (e.g., BMO’s 3.75% 5-year fixed promo and CIBC’s 3.99% cash-back promo)
• They surprised the market by uncharacteristically lowering fixed rates–despite bond yields surging over 30 basis points, and despite rate increases from certain non-bank lenders.

There’s something going on behind the scenes.

The Big 5’s mortgage divisions are morphing from Gomer Pyle to John Rambo…fast.

Bankers are running through the jungle with M-60’s, whereas in kinder and gentler times (pre-2009), they sat camouflaged in the weeds with sniper rifles.

Beyond the war analogies, the truth is this.  Banks have long been satisfied with advertising above-market rates and discounting them on an as-needed basis. They would reserve deep discounts (a.k.a, “rate discretion”) for their best customers.

Banks are now coming out of the bushes and changing their tactics.

When RBC cut rates last Tuesday, its mortgage executives knew that certain competitors would be raising rates. They knew that timing a rate cut, when people expected a rate hike, would draw attention. It was very calculated.

Meanwhile, BMO and CIBC fired their own salvos. They launched advertised rate specials at a mere 95 and 70 basis points above the 5-year GoC yield. Historically, banks have rarely offered these discounts to even their best customers.

To put a spread of 70 bps in perspective, John Bordignon, EVP Strategic Development at Paradigm Quest, says:

“Prior to August 2007 (the start of the “Liquidity Crisis”), gross spreads between Government of Canada (GoC) bonds and market rates, historically averaged 125 bps (Jan 2000 to August 2007).

From July 1, 2009 to March 1, 2010, we have seen fixed-rate spreads reduce by 70 bps, and ARM rate spreads reduce by about 55 bps.”

There is no doubt. 70-95 basis point pricing is incredibly tight.

“The fact that banks are going well below traditional levels tells you one of two things,” John says. “Their overall cost of funding is low and/or they are willing to take less or no profit in order to obtain market share.”

It looks like a combination of both.

Market share is the big banks’ drug of choice during the spring real estate market, and they’re desperate to get their fix. BMO and CIBC both lost market share last year so they, in particular, seem plenty anxious to regain some ground.

“Customers have told us that they want to become mortgage-free faster, pay less in total interest, and have the comfort of a fixed-interest rate. We’re aggressively going after mortgage business,” a BMO spokesperson told us.

The stakes are high. Insured mortgages are one of the best assets a bank can have.

• They reflect positively on a bank’s balance sheets and capital weightings.
• Even if banks don’t yield much profit during the first term, their high customer retention rates (80%-90%) ensure healthy profits in the 2^nd and 3^rd terms.
• Banks enjoy all the other profitable business that having a mortgage customer brings (deposits, accounts, investments, insurance, etc.). Non-bank (“monoline”) lenders typically don’t have complementary revenue sources.

On the funding side of the equation, banks have another huge advantage over small and non-bank lenders.  Banks’ ‘nuclear threat’ comes from having billions of dollars of low-cost deposits. Smaller lenders either don’t have deposits, or have to pay more to get them.

Secondly, banks have notably lower securitization expenses.  In other words, it costs banks less to sell your mortgage to investors—which gives banks cheaper money to lend to the next guy.

Central to Canada’s mortgage securitization process is the hugely popular Canada Mortgage Bond (CMB) program.  When lenders sell mortgages into the CMB program, they require things like:

• Issuer status. Unlike banks, smaller lenders often don’t have direct “CMB issuer status.” That means they are are forced to use middlemen (called aggregators) to liquidate their mortgages. This is necessary so the lender can relend that money to other customers. Small lenders have to pay upwards of 30 bps or more for this service.
• Warehousing.  Non-bank lenders sometimes incur steep “warehousing” costs. These are costs paid for short-term money. This short-term money is used to fund mortgages until those mortgages can be sold to someone else.
• Swap counterparties. These are financial institutions that manage interest rate and pre-payment risk in the securitization process. As a ballpark, big banks can do swaps for maybe 10 bps cheaper than their competition.

Many independent mortgage lenders today are pinned down.  And it won’t get any easier in the short term.

Lender execs tell us the rate wars could last all through the spring market.

We’re wondering if it might last even longer. 

In the past year, we’ve seen far more widespread price undercutting. Banks have always had spurts where they get aggressive, but it seems their aggression became more sustained, after last winter. If they continue on their current path, all of this will take market share from brokers–in the short term at least.

As for rates, things could stay nasty from a lender’s viewpoint. One capital markets expert we spoke to, says banks can price as low as 40-50 bps above their internal cost of funds, if they have to. That’s less than 1/2 of what they’d price at ‘normally.’ In exceptional cases, they may decide to take a loss in exchange for a client. Non-bank lenders don’t have these flexibilities.

So what conclusions can be drawn from all this?

1. It’s good to be a bank
   (which explains why OFSI is flooded with bank applications right now)
2. If you’re a broker, it’s good to have good relationships with banks
3. If you’re a lender, who’s not a bank, odds are you’re currently working on your bank application…or arranging third-party funding partnerships to secure a cheaper source of funding than the CMB program.
4. Many non-bank lenders will not be able to compete at these reduced margins.
5. We need to support non-bank lenders who go out of their way to offer clients and brokers better options than the banks.  As two examples (and there are others), MCAP and Merix both have terrific spring specials at the moment. You can get as low as 1.75% now on a 5-year variable, or 2.87% on a hybrid mortgage (50/50 fixed/variable). These promotions are available only through brokers.

Last modified: April 28, 2014