This past week, investors and Canadians at large experienced something exceptional. The Bank of Canada increased interest rates by a quarter basis point. Although this event previously occurred much more often than once every seven years, the country has not been able to sustain higher interest rates since the recession of 2008/2009.
What this means for everyday Canadians is a higher cost to borrow money. The good news is that borrowers will not have to shoulder these costs overnight.
For variable rate borrowings, such lines of credit, the higher interest rates will take one month to be felt by borrowers as major banks have increased the prime rate, and interest charges are levied on a monthly basis. As a reminder, the interest rates on variable loans and lines of credit are based on the prime rate plus a spread.
Given the higher rates of interest, borrowers will have to spend a little more money to finance the amount they have borrowed. For a $10,000 loan, an increase of 25 basis points will translate to monthly payments which are $2.08 more. For a $500,000 mortgage, the additional quarter point translates to a higher monthly payment by close to $100 per month.
This also means that the lender will receive a higher amount of revenue for every dollar that is loaned. Although the lender must now pay a higher rate of interest on money that is brought in from savers through the issuance of guaranteed investment certificates (GICs), the reality is that the 25 basis points will not flow to clients. Investors will happily see the spread increase as a result of the increase in interest rates.
For investors considering where they can benefit from the quarter point increase in interest rates, the answer may just be that they need to consider the lenders.
Taking shares of Canadian Western Bank (TSX: CWB) as an example, the lender may now experience higher revenues as a result of the higher interest rates. Given that the company’s operations are focused in western Canada, it is important to realize that the bank will not be as diversified as Canada’s Big Five, which are based in the eastern part of the country.
The bank, which has much smaller “add-on” businesses, such as insurance or estate planning, will stand to benefit most from the increase in interest rates. With many longer-term mortgages and matching GICs already locked in for a period of up to five years, the climb up the hill which will result in higher revenues will be gradual and rewarding for investors still for years to come.
Although many investors have feared higher interest rates for a very long time, the truth is that there are still areas of the market that will experience benefits from these increases.
