Did you know that interest rates are rising in Canada?
It’s true. The Bank of Canada spent all of 2022 raising its policy rate. In 2023, the bank paused, but the upward march of financing costs continues, as treasury yields rise to match the levels implied by monetary policy. Today, it’s common for Canadian mortgages to be originated at interest rates of 7% or even 7.5%. The cost of financing a house in Canada has never been higher. Even in the 1980s, when interest rates went all the way up to 20%, total financing cost wasn’t as high as it is today, because house prices were so much lower then. 7% interest on a $500,000 house is more dollars than 20% interest on a $100,000 house.
Rising interest rates create challenges for everybody, but they’re especially pernicious for retirees. Retirees usually live on fixed incomes, which means that they don’t get “pay raises” like workers do. The Canada Pension Plan (CPP) has an inflation indexing element, but it’s a fairly modest component of most retirees’ pension incomes. Defined benefit pensions typically make up the bulk of peoples’ pension income, and those pensions are typically fixed. So, in a rising rate environment, retirees face the risk of watching interest payments rise while their incomes do not.
Rising rates: The risks
The basic risk of rising rates for retirees is the risk of financing costs growing while pension incomes stagnate. Some specific risks that come from this include
- Rising mortgage costs;
- Rising credit card interest;
- Lower values of pension/Tax-Free Savings Account/Registered Retirement Savings Plan assets; and
- Higher overall costs of goods (if you count the inflation that kicked off the interest rate hiking as part of the problem).
Basically, high interest rates make asset prices go lower, and financing costs go higher. For those with a lot of debt — including many retirees — that’s a problem.
Rising rates: The opportunities
Although rising interest rates present many risks to Canadian retirees, they present opportunities as well. Some assets benefit from rising rates, and they may make good investments today.
Take First National Financial (TSX:FN) for example. It’s a Canadian non-bank lender that makes money by issuing mortgages. When interest rates rise, interest income rises, too, so lenders are among the few types of companies that can earn rising profits in high-rate environments. This point applies to banks as well as non-bank lenders, but banks don’t always win out when rates rise, because they might face bank runs when depositors flee for ever-higher yielding treasuries. Non-bank lenders like FN simply issue the loans they need to conduct their business — much more straightforward.
How is First National doing with its deposit-free business model?
Pretty well!
In its most recent quarter, the company delivered
- $138 billion in mortgages under origination, up 8%;
- $526 million in revenue, up 26%;
- $90 million in pre-fair market value income (i.e., income not factoring in asset price changes), up 61%;
- $89.2 million in net income, up 46%; and
- $1.47 in diluted earnings per share, up 46%.
As you can see, every single one of FN’s key profit metrics increased by high double digits in a quarter when Canadian banks barely grew their earnings at all. This shows the virtue of being a non-bank lender in a time of rising interest rates and inverted yield curves.
