Safe, sturdy GICs suddenly in focus amid Canadian subprime mortgage storm
TORONTO May 3 The troubles engulfing Canada's non-bank mortgage lenders have cast a spotlight on a popular and dependable investment product that is a central part of financial life in the country, from grandmothers giving gifts to serving as the funding model for listed companies.
Canadian alternative lenders Home Capital Group and Equitable Group Inc, which rely heavily on guaranteed investment certificates (GICs) to fund operations, saw withdrawals from another savings product last week as depositors got spooked by regulatory allegations against Home Capital.
The withdrawals from high interest savings accounts (HISA), including a 75-percent drop in Home Capital's HISA deposits and a far lesser decline at Equitable, spurred Canadian banks to provide a credit line to Equitable on Monday to prevent it spreading to other deposits, including GICs.
Equitable said on Wednesday that a sixth major Canadian bank had joined the syndicate for the facility.
According to Bank of Canada data, personal fixed-term deposits, of which GICs are a subset, totaled C$320.43 billion as of January 2017. This accounts for about 18.2 percent of all chartered bank deposits in Canada. The central bank and other financial authorities do not break out GICs' share of the total. "Everything is to stop the panic. That's why banks stepped in to provide credit lines. Why risk it?" said a Canadian financial market participant who declined to be identified because he is not authorized to speak to media.
As depositors pull their money out of Home Capital Group, focus has turned to the long-term outlook for GICs as a funding source for alternative lenders.
The popularity of GICs, despite their low interest rates, is due to their safety. Unlike with stocks, a GIC owner can never lose money on their principal. Those bought from members of Canadian Deposit Insurance Corp (CDIC) issuers – such as banks, alternative lenders – are insured for up to C$100,000 ($73,201.08).
GICs' terms usually range from 30 days to five years, often require a minimum deposit of at least C$500, and can earn annual interest rates of up to 2.5 percent on a five-year term. The rates, while conservative, beat the near-zero interest rates offered by most regular savings accounts today.
On Monday, even as its shares slumped 28 percent, Home Capital-owned Oaken Financial ran a full-page ad in a national newspaper, marketing its GICs, which are similar to certificates of deposit in the United States. "Everybody likes permanent funding," said Barry Schwartz, portfolio manager at Baskin Financial Services. "(GICs) are very important because they are a very low-cost funding and the banks get to lock you up at crummy rates for the long term.
"Could (the banks) live without GIC sales? Sure. But banks love them because you can't pull out your money."
WHAT'S THE ALTERNATIVE?
Unlike traditional lenders, which rely on a variety of deposits to fund their operations, non-bank lenders like Home Capital and Equitable derive roughly three-quarters or more of their funding needs from GICs, underscoring the heavy reliance on these short- to medium-term deposits.
The immediate funding squeeze at Home Capital has come from the HISA withdrawals. But with short-term sentiment turning against non-bank lenders, some analysts question whether the worry could spill over.
"The biggest concern with Home Capital is liquidity, what's going to happen with their GICs. If they can't underwrite their GICs, then you're in a run-off scenario," one Toronto-based banking analyst said. "We don't know if people are taking new GICs or not. It's a hidden market right now.
"As these GICs reach maturity, are people re-buying them? That's the question," the analyst added.
As Toronto's housing market boomed, attracting new buyers who at times fell short of big banks documentation standards, Home Capital and other non-banks came to their rescue.
For years, non-bank lenders were accustomed to depositors renewing their GICs, giving them a constant supply of low-cost funds required to underwrite new mortgages.
Withdrawals from GICs have been limited since there is a penalty for premature exits. Home Capital's total GIC deposits stood at C$12.86 billion down from C$13.06 billion at the end of March.
Whether investors will rush to buy new GICs offered by non-bank lenders remains to be seen.
"It probably does change people's perception. I can certainly see some investors being reluctant to buy GICs," said Dan Bortolotti, associate portfolio manager at PWL Capital.
"But what's the alternative? If you were to look at other alternatives, what's less risky than a GIC?" ($1 = 1.3676 Canadian dollars) (Additional reporting by Fergal Smith and Anna Mehler Paperny in Toronto and Leah Schnurr in Ottawa; Editing by Nick Zieminski)