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So why are the long term fixed borrowing rates so much higher than shorter term rates at present?

5 reasons why there is such a difference now:

1. OCR doesn’t correlate well with long-term interest rates

2. Risk premium for OCR rises

3. Deposit rates:

The Reserve Bank Governor, Dr Alan Bollard has just announced that the Official Cash Rate (“OCR”) is to remain unchanged at 2.50%.  This move was widely expected by economists.  On discussions with my business banking contacts they say that they have already factored in a 0.5% increase into fixed rates by 30 June of this year.

Dr Bollard’s press statement interestingly said that:

the New Zealand economy continues to recover…

The economy is being assisted by both monetary and fiscal policy support…

If the economy continues to recover in line with our December projections, we would expect to begin removing policy stimulus around the middle of 2010.”

As a result I predict that the major banks will not change their floating rates, but perhaps edge up their 1 – 3 year rates a little bit further.  The floating rates will rise when the OCR rises.  I predict that the OCR will stay unchanged on March 11, April 29, but then rise by 0.25% on 10 June 2010.

Right now 4 and 5 year fixed rates are over 8%, and that means that they are over their 10 year averages.  With the very steep yield curves from floating below 6% to fixing for 5 years at ~8.5%, I think that their would have to be a very compelling reason to fix for 4 or 5 years right now.  Yes I did fix money for 5 years in March as I blogged about (scroll down) earlier in the year, but that was at 6.50%.  Bet you are glad you followed my advice then!

Check out the yield curve on interest rates below.  I attended another good property seminar run by ANZ’s Mobile Mortgage Managers in my capacity as Vice President of APIA, and they gave me this graph to insert in my blog when I told them I was doing one:

ANZ’s Interest Rates across all terms

Look at the floating and fixed rates below 6%, and how high the 4 and 5 year rates are.   In fact from the 6 month fixed rates all the way up to the 5 year rates you can clearly see how steep the yield curve is.  You are now paying a very real premium for risk.

So if you didn’t, couldn’t or wouldn’t follow my instruction to fix long (for 5 years) back in March, perhaps consider my thoughts to keep to short term 1 year, 6 month or floating rates.  I am a massive fan of revolving credit loans, which when used properly, give you massive flexibility to repay principal and to redraw when you need to (eg. replace that 50 year old leaky roof, and when the right deal approaches to be the deposit on your next property purchase).  Why not consider floating or taking 6 month interest rates (5.29% with Westpac right now, 5.4% with BNZ, 5.45% with ANZ etc) or 1 year rates 6% or lower.

Why I am not taking long term rates right now?

Our Reserve Bank governor stated that he was not going to lift the OCR “until the later part of 2010″.  This gives some certainty that the floating rates will remain low for a period of time to come.   The market for some unknown reason is not believing Dr Bollard and are pricing in around 1.25% worth of hikes to the OCR.  Now with the US economy in such a dire state still, and the NZD:USD at a high level of $0.75, can you really see the Reserve Bank hiking our OCR.  That would murder already struggling exporters.  The new liquidity rules the Reserve Bank has brought in, act to penalise long term borrowings from offshore.  As a result savers for 3 – 5 year fixed rate term deposits are being rewarded with higher interest rates, as it is easier and less expensive to source funds from NZ, as opposed to abroad.  Borrowers are shortening their duration as Reserve Bank statistic show.  Since June 2009 fewer than 10% of all borrowers are fixing for 3 years or longer.  This is actually very interesting as it will mean that the Reserve Bank gets far greater traction when it raises and indeed in the future lowers the OCR, as far more people are on floating rates.

In Australia their are far fewer borrowers fixing, and they traditionally have a significant number on floating rates enjoying the flexibility to pay down principal without incurring break fees, but also lenders compete aggressively over floating rate lending.  In NZ typically the 2 year fixed rate has been the most competitive one, with memorable campaigns by Government owned Kiwibank, and also BNZ with their “unbeatable” campaign.  Nowadays times are changing and I saw in Westpac last week their 5.29% 6 month rate as their “poster rate” on three busy Auckland branches and ANZ and ASB competing on the basis off their floating rate – plastered all over the walls and windows of their branches.  Perhaps this is a good structural change.

Break-even rates

On this basis I believe that with loans coming up for rollover to not take a 3 year or higher rate.  I am not even a fan of 2 year rates right now.  I am now going back to an interest rate averaging strategy but with a good deal of debt expiring in 2014 from my efforts in March this year, I am now looking at some shorter term rates, and am fixing for 6 months at present.  Look at the break-even rates to mean getting a better return.  If I were to fix for 6 months at 6.45%, that the 18 month would have to be 7.5% or higher in April next year, to make the 2 year rate better! And also note that I haven’t even tried to model the increased beneficial effects of repaying more principal down whilst you are benefiting from such a low sub 6% interest rate.

If I wanted to fix for 1 year, I still wouldn’t as fixing for 6 months at 5.45%, would mean for the remaining 6 months at April 2010, the rate would have to be 1% higher at 6.45% of higher.  I just don’t see this happening.  Now do your own reading (I read and thank BNZ, Westpac, ANZ and ASB’s economic commentaries all the time so share some high level of influence from them) and own calculations in deciding what is right for you.  I am going short though!

Members should take note that the Reserve Bank today (30 April 2009) reduced New Zealand’s Official Cash Rate (OCR) from 3.0% to 2.5%, with Reserve Bank Governor Alan Bollard commenting:
“Overall, developments since March point to lower medium-term inflation than previously projected. The main factors behind this are weaker global growth, and an unwarranted tightening in financial conditions via both higher long-term interest rates and a stronger exchange rate than expected.  Global financial markets have showed some tentative signs of stabilisation since the March Monetary Policy Statement and governments in the major economies are continuing to make progress in resolving their banking system difficulties. However, a large amount still needs to be done and sentiment remains fragile. Negative feedback from the global recession could also still adversely affect financial institutions. The world economy deteriorated further than expected in the first quarter of 2009. While monetary and fiscal policy responses in many countries have been substantial and there are some signs of stabilisation in some countries, we still expect the adverse economic forces generated by the crisis to remain dominant throughout 2009. The timing and extent of global recovery remain highly uncertain. While the New Zealand economy has not experienced the same extreme falls in economic activity as seen in a number of our trading partners, it remains weak. Business sentiment is low, investment has been curtailed and employment reduced. We expect the large decline in the OCR over the past year to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing. This, together with the stimulus from fiscal policy, will act to support the New Zealand economy and eventually see activity trough and pick up thereafter. However, the scale of the global financial crisis and domestic adjustments underway are such that it is likely to be some time before economic activity returns to robust and healthy levels.

We consider it appropriate to provide further policy stimulus to the economy. We expect to keep the OCR at or below the current level through until the latter part of 2010. The OCR could still move modestly lower over the coming quarters.”
We have seen numerous cuts since the OCR peak in this interest rate cycle at 8.25% where it stood for a year until 24 July 2008.  This year we have had 2% cut off it alone with the 12 March policy announcement being a 0.5% cut, and the January 29 policy announcement being an unprecedented 1.5% cut.  The encouraging words from Dr Bollard are that there are “more in the pipeline” indicates a far deeper recession than previously contemplated, so like other Central Banks in the world he will try to stimulate the our economy with lower interest rates for business and household lenders.  This will flow onto lower interest rates for investors.  Other Reserve Bank heavyweights Tim Hampton and John McDermott were also present answering questions with Dr Bollard.  Sometime they mentioned which is important to consider is that to be competitive in International Captial Markets we can’t be like the US Federal Reserve, Canadian Reserve Bank and Bank of England who have 0.5% of lower equivalents to the Official Cash Rate.  I am predicting at this early stage only a 0.25% cut in the OCR at the next 6 weekly policy announcement on 11 June 2009, which is also where the 3 monthly Monetary Policy Statement will be presented.

While the New Zealand economy has not experienced the same extreme falls in economic activity as seen in a number of our trading partners, it remains weak. Business sentiment is low, investment has been curtailed and employment reduced. We expect the large decline in the OCR over the past year to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing. This, together with the stimulus from fiscal policy, will act to support the New Zealand economy and eventually see activity trough and pick up thereafter. However, the scale of the global financial crisis and domestic adjustments underway are such that it is likely to be some time before economic activity returns to robust and healthy levels.
Dr Bollard stated that “we consider it appropriate to provide further policy stimulus to the economy. We expect to keep the OCR at or below the current level through until the latter part of 2010. The OCR could still move modestly lower over the coming quarters.”

We have seen numerous cuts since the OCR peak in this interest rate cycle at 8.25% where it stood for a year until 24 July 2008.  This year we have had 2% cut off it alone with the 12 March policy announcement being a 0.5% cut, and the January 29 policy announcement being an unprecedented 1.5% cut.  The encouraging words from Dr Bollard are that there are “more in the pipeline” indicates a far deeper recession than previously contemplated, so like other Central Banks in the world he will try to stimulate the our economy with lower interest rates for business and household lenders.  This will flow onto lower interest rates for investors.  Other Reserve Bank heavyweights Tim Hampton and John McDermott were also present answering questions with Dr Bollard.  Sometime they mentioned which is important to consider is that to be competitive in International Captial Markets we can’t be like the US Federal Reserve, Canadian Reserve Bank and Bank of England who have 0.5% of lower equivalents to the Official Cash Rate.  I am predicting at this early stage a final 0.25% cut to the OCR in this economic cycle at the next 6 weekly policy announcement on 11 June 2009, which is also when the 3 monthly Monetary Policy Statement will be presented.

Westpac have already slashed 0.4% off their 6 month rate, and I understand all major lenders are reviewing their interest rates today.  The effect of this announcement is likely to pull down the floating, 6 month, 1 year rates, and 2 year fixed term rates and perhaps a trimming to the 3 year rate, as Dr Bollard in an unusual move suggested that the rates would remain low until at least the end of next year.  This strongly implies for the next 18 months that rates will not rise from where they are now.  Expect to see more cuts to the short term fixed rates and floating rates from various lenders today!

What Should I Do About This?
I would encourage all members to review their current loan portfolio and to work out an interest rate and loan strategy with their brokers or bankers.  It will be interesting to watch good sites like http://www.goodreturns.co.nz/mortgage-rates.html to get up to date interest rates, and www.sorted.org.nz to see the reaction to the Reserve Bank’s move to state they expect interest rates to be low until the end of 2010.  This move was possibly learned from the Reserve Bank of Canada where they found a way to impact longer term fixed rates (which Dr Bollard is frustrated by them rising).  In an unorthodox move they stated that they would not raise the OCR until at least the 2nd quarter of 2010.  We have implied no rise in the OCR at least from current levels until the end of 2010.  Watch and hope for medium term interest rates to fall with this significant level of certainty.

Interest costs are typically the greatest expense for property investors, so I look forward to hearing from the Deputy Reserve Bank Governor Dr John McDermott at the Auckland Property Investors’ Association meeting in July this year.  It will be great to understand where various interest rates are heading and why.

Well there have certainly been a number of changes in the market recently, with the OCR having dropped from its peak in this economic cycle of 8.25%, down to just 3.00%, and I believe it will drop a little bit further.

Just remember that the OCR was put up to 8.25% on 26 July 2007, and stayed that high until 24 July 2008 where 0.25% was shaved off to lower the OCR to 8.00%, and every 6 weeks since then we have seen cuts, including the 1.0% cut on 23 October 2008, as well as the massive 1.5% cuts on the 4th of December 2008 and the 29th of January 2009. These cuts made Thursday’s 0.5% cut to 3.0%, seem like a bit of a let down.

Whilst I feel for term deposit savers, and pensioners that have a lot of their money in term deposits, we are a nation of net borrowers, not net savers.  Therefore lower interest rates are of benefit to the country.  Take note that our OCR is far cheaper than those in developed countries of the world like the UK, USA, Japan etc.  These changes to financial markets are interesting for us as property investors and/or home owners as our lender’s interest rates have come cannoning down.

Look at the current rates now and compare them with just 6 months ago.  I was paying over 10.5% as a floating rate in September and most fixed rates were pre-fixed with a 9.x%.  Now most rates are pre-fixed with a 6.x%, as well as several 5.x% rates too. The long term fixed rates look like outstanding value to me.  I think that with the US 5 year swap rate at cyclical lows, and the 5 year fixed interest rates at levels not seen for 6 years in New Zealand, that it is a great time to fix your buy and hold investment properties for a long time.  I am throwing my interest rate averaging schedules out the door, and I am fixing as much as possible for 5 years at 6.50%.

This is cheap money, and my business banking managers and brokers that I network with are saying that they are being inundated with requests to fix long.  This will also mean that you have to hurry up, as the supply/demand argument will kick in, and banks will be able to charge more for the certainty that this 5 year fixed rate will offer you.

Don’t miss the boat on this one – get some interest rate and cashflow certainty and fix long today.  Long term fixed rates will go up from here, not down on the most part.  For those lucky enough to be with BNZ, consider their 7 year 6.79%  (this is not a misprint, I do mean seven year) fixed interest rate.  That is rate certainty out until 2016 when the market should be well recovered and booming by then.  Note that if you are expecting an inheritance, redundancy payout or other lump sum, that you are best to keep a good portion of your borrowing on a floating rate or short-term fixed rate, to allow pay downs without incurring significant penalties.

Pavarotti’s memories will live on

After 40 years of Lucianno Pavarotti performing opera and 71 years of life Lucianno Pavarotti passed away today.  The sheer power the might tenor brought to Nessun Dorma (from Puccini’s Turandot) in the Soccer World Cup 1990 in Italy was enough to get me Interested in Opera.  I started learning the guitar the following year and actually asked my parents to join them at Opera and Musicals after that.  Whilst I love and prefer pop music, the magic of a night at the Opera canot be underestimated.  The history of previous performers and mesmering voice with full orchestral accompaniment is so powerful.  (Here’s Nessun Dorma live and made to be played loud – note go to http://www.youtube.com/watch?v=VATmgtmR5o4 if my 20 minutes of tinkering do not come to fruition and this doesn’t play smoothly first time)

Pavarotti also performed with U2 to sing Miss Sarajevo in 1995 that stormed the pop charts.  He was a strong supporter of charities and a true superstar of Opera and indeed the music industry.  RIP Lucianno.

Finance Companies going under

Yes many finance companies have gone under recently.  Listening to some Newstalk ZB talkback on my drive arounds (I do a lot of driving checking properties under contract, meeting clients on site, development professionals and contractors etc) I am concerned that many people think finance companies collapsing mean the market is collapsing too.

That is not the case.  The property market is not collapsing, and some commentators views that the market will fall by over 25% in the next year are sensationalist and over the top to say the least.   Sure the boom times simply cannot continue as they are now too far ahead of the underlying fundamentals, but a NZ collapse is most unlikely to happen. Yes, some investors and home owners have over extended their borrowing and do not have sufficient non rental income sources to cover their Mortgage payment, or face having to sell their properties.

It is no secret that some property owners are finding things tough at the moment.  I know an investor that had fixed 4 years ago $1 million of borrowing at 6.5% that is going to be refixed at 9.2%.  Yes they need to get another $27,000 per year to cover this increase that hits them next month.

Questions I have been asked by investors include – what happens to the money I have borrowed from my finance company which is in receivership?  Generally no issues here, your loan continues as is.  The receivers may try to revive their struggling companies, however they are likely to sell their “book” (your loan is an asset to them) to a number of well heeled parties that may sniff a bargin.  It may get taken over by another lender.

Will other finance companies fall?  Yes they will.  However the Securities commission has now stepped in and is seeking statements of finance companies health.  Some that have not provided such statements to date and that their are rumours about, are on thin ice and summer is fast approaching.

What happens to my money I invested with Bridgecorp/LDC/PFS/Nathans finance etc?  You may get it all back, but after receiver’s fees are paid (they are protected by law to be paid first, then secured creditors etc), you are likely to get back just a portion of what you invested, aka the Metropolis junk bonds from 2002.  My advice is look for reputable providers that you can trust or invest in property via a listed managed fund (eg Macquarie Goodman property Trust, Kiwi income property Trust etc).

So don’t worry too much about these finance companies collapsing.  The property market is not soaring up like it has in previous years – so lesser prepared people will be suffering more pain at the moment.  Also NZ will not have the lending issues in the sub prime market such as what happened in the USA recently.  The reason is the no financials self declared income products did not have the overly “keen” levels the lenders provided in the US – I am advised that one provider gave 100% finance with non financials and self declared income!  In NZ no financials and self declared income products were at much lower levels (typically 60-80%).

While there has been some fuss made over TV3s Deal or No deal show lately, I think there is a mountain being made out of a molehill. If you don’t like how some models cleavage is showing don’t watch it. If you don’t like your kids watching the show as they may get wrong ideas, since they are your kids don’t let them watch it. The same goes for if you are at the beach and men and women are wearing little if nothing and that offends you, or you are repulsed by a 75 year old plus man wearing speedos, exercise your freedom of choice to not look. So quit complaining, out your energy to constructive things and don’t look at Deal or no deal if you don’t like it.

OCR rise to 8.00%

In a similar vein some people are stressing majorly over the fact the OCR has been raised. Some investors and home owners are panicking thinking how are they going to pay their home loans now, will be get foreclosed on, how am I going to retire rich now, what if Interest rates go up to 13%!

Guys it is time to take stock of what happened. I know may be news to some people, but the sun will still rise tomorrow. Team New Zealand will still win the Americas Cup again (if not now soon enough), the All Blacks will still demolish all in front of them. Firstly remember that only your loans on floating/variable Interest rates are effected. Even if you have an average $300,000 of borrowings on floating, the latest 0.25% Interest rate rise will be $750 on your pocket. Not that big a deal.

Improving your return

However if you are more exposed and have fixed debt that will shortly be off the ‘cheap rates’ then you may have an issue. Maybe you need to renovate and add value to your rentals (do up properties to make them desirable to attract good tenants and get better rental returns), consider putting on a minor dwelling, sleepout or subdividing and selling your property. Can you fix your floating debt to get better Interest rates and loan terms. Can you use Lease Options to get some more cashflow. Can you adopt some propertytrading in this changing market.

The answer is: you can do all these things. The real question is what is holding you back right now?

In life sometimes it is like playing a game of deal or No deal. Because it is easy you just say No deal all the time. Why not be positive and looking at your situation – if you can do a deal that will get you ahead – do it…

PS: Grats Team New Zealand on annihilating Prada 5 – 0 to win the Louis Vuitton Cup and right to challenge Alinghi on June 23 – this was a thrashing that every Kiwi enjoyed