Posted by: Daryl & Wendy Ashby | December 5, 2010

Prime – 1% Variables ?

“We definitely believe it’s going to get back to prime minus 1…It’s a rate war out there.”

That’s a broker talking about variable rates, as quoted by the Globe & Mail a few weeks back.

If we truly knew variable-rate mortgages were headed back to prime – 1.00%, we could strategize appropriately. For example, 1-year terms would be even more compelling—on the assumption borrowers could renew into even cheaper variable rates 12 months hence.

 John Bordignon, EVP Strategic Development at Paradigm Quest, says, “Consumers have been asking for adjustable rate mortgages (ARMs) more and more, which in my view is one of the reasons we’ve seen such competitive pricing.”

“In the broker channel at least 65% of the volume has been ARM versus fixed,” says Bordignon. “Historically it’s the other way around—65% fixed, and the balance ARM.”

 George Hugh, Vice President, Lending Sales at ING Direct, tells us: “We can’t expect much more discounting.” Hugh senses that profit spreads on variable mortgages are near their minimum.

“We’re in very abnormal market conditions. Mortgage pricing is being driven by excess demand for mortgage business from balance sheet lenders (big banks).  For the most part, these needs are being driven by securitization and other debt issuance programs.  In addition, the Big 5 banks still have a ton of deposits where they pay ‘zero’ interest…and they have to put that money to work. This excess demand is causing mortgage spreads to deteriorate. But now we’re pretty well at a floor.”

“There seems to be a perception that prime – 1(%) is coming back,” Hugh says. “I don’t feel we’re going back to the prime – one days. There’s too much risk in the market and not enough spread for that risk.”

At prime – 0.65%, today’s gross variable-rate spread is roughly 108 basis points (2.35% minus the 30-day banker’s acceptance rate). That’s materially under the 120+ basis points that lenders have typically required in the past. From that gross spread, lenders need to pay securitization costs and/or liquidity premiums (in the case of banks using transfer pricing), hedging costs, underwriting costs, overhead, marketing costs, sales force compensation, etc.

At prime – 1%, Hugh and Bordignon feel spreads would be unsustainable.

That said, there’s always the chance lenders may someday offer short-term prime – 1.00% promotions or “teaser rates”, but Bordignon feels, “We will not see prime – 1.00 as everyday pricing.”

Over the next few quarters, people may shift more into fixed-rate mortgages says Bordignon. “As prime increases, and it will, I think we will revert back to historical splits. That will ease demand for ARMs. In addition, banks won’t want to give up a lot of spread in the first quarter of their year, which begins November 1st.”

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