BC Property Tax Deferment

The BC government in the previous budget is now enabling people that own homes and financially supporting somebody that is 18 years old or younger to defer their property taxes, at the rate of interest of the bank prime rate. Previously only seniors (55 and older) were able to exercise this option.

Essentially homeowners are given the option of borrowing money (the amount of their yearly property taxes) at the prime rate, and will only have to repay this amount when your property is transferred (i.e. you sell the place).

Almost everybody that is financially sophisticated that is eligible to do this should be exercising this option. Getting money at the prime rate outside a mortgage is not that easy, and at the prime rate you can very likely make an investment that would give a higher rate of return.

The trick is making the interest amount tax-deductible, and if you use the deferred property tax amount for income-generation purposes then in theory you should be able to deduct the interest.

British Petroleum and the drilling companies

I have done nothing other than look at the summary financial statements of BP, but on paper they look undervalued. The mess in the Gulf of Mexico, however, will be costing them considerable amounts of money. I’ve projected a couple years of earnings ($40 billion) that will likely go down the tubes as a result of this environmental incident.

The market will take BP down to the point where nobody will expect, and when everybody has written off the stock, that is usually the time to buy. In essence, this is a psychological play, so it involves more game theory than financial analysis since it is likely that BP will remain a continuing entity in the future. Their balance sheet is fine – about $40 billion in debt and $7 billion in free cash flow ($20B income) in 2009, so they won’t be facing any solvency issues.

The better question is whether one should invest in the drilling companies. It is likely lease rates will drop since offshore drilling will have significant demand drops and the market has already been pricing this in. As an example, Transocean has also been slaughtered.

I generally do not look into companies that are not trading in Canada or the USA, and BP is a British company, so I will not be considering them seriously. However, the other companies (e.g. the aforementioned drillers) I will be investigating. Since there are so many eyeballs on this sector, there must be other circumstances (e.g. panic) that would be required to ensure that you are getting good value for your investment. It is also exceedingly difficult to predict when to catch the falling knife and the investment to invest in BP is essentially that – you need to place your purchase orders when everybody has gotten their hands so bloodied up trying to catch the knife that they have given up trying.

I would not bother thinking about this until BP has cut their dividend.

Eating a little bit of crow on interest rates

I strongly thought the Bank of Canada was going to raise 0.5%, and the futures markets were not inconsistent with this belief, but instead, they raised 0.25%. Global factors (including Europe) is likely the reason why they went for the more conservative rate hike. They have also said that future rate hikes are not going to be as quick as the markets anticipated:

In this context, the Bank has decided to raise the target for the overnight rate to 1/2 per cent and to re-establish the normal functioning of the overnight market.

This decision still leaves considerable monetary stimulus in place, consistent with achieving the 2 per cent inflation target in light of the significant excess supply in Canada, the strength of domestic spending, and the uneven global recovery.

Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.

Now that I have completely destroyed any credibility that I had on the issue of short term interest rates, I will give my new projection:

July 20 (raise 0.25% to 0.75%)
September 8 (raise 0.25% to 1.00%)
October 19 (raise 0.25% to 1.25%)
December 7 (raise 0.25% to 1.50%)

Between now and the end of the year, the prime rate will rise from 2.25% to 3.50%, and your average variable rate mortgage of prime minus 50bps will go from 1.75% to 3.00%.

There is no indication that these quarter point rises will stop in 2011; although the markets are now hinting the short term rate will level off around 2.75% (prime rate of 4.75%). This will clearly be conditional on how fast the economy recovers and the onset of inflation.

Bank of Canada Interest Rate projections

The June 3-month banker’s acceptance futures are trading at 0.89% at present.

This suggests that the short-term interest rates (the target overnight rate) will likely raise 0.5% to 0.75%. However, the banker’s acceptances generally are a quarter point over the prevailing target rate, which suggests the market is pricing an approximate 40% chance that the Bank of Canada will only raise 0.25%.

One month T-bills are at 0.23%, 3-month T-Bills are at 0.47%.

My justification for a 0.5% raise is simple – they want to make a statement.

I rarely have strong feelings about currency trading, but my guess is that the Canadian dollar will spike briefly on the announcement and then will go through a decline.

Most of the media thinks that the Bank of Canada rate increases will result in currency appreciation, but they will get the opposite results – low interest rates causes a lot of currency holding through carry trading. Since traders are on the margin side, a higher rate will result in currency outflows. It is likely the US dollar will be the one to rise relative to the Canadian dollar, so I’d get your cross-border shopping in sooner than later. You can also do “cross-border shopping” by buying US equities. The markets suggest that the US federal reserve will start raising rates around the beginning of 2011.

Canada ends the fiscal year with $47 billion deficit

The 2009-2010 year-end fiscal monitor is finally released. I will make some year-to-year comparisons.

From April 1, 2008 to March 31, 2009 the government posted a $2.2 billion deficit. In 2009-2010, the government posted a $47.0 billion deficit.

Revenues were down about 5% year-to-year, mainly attributable to a decrease in personal income tax and corporate income tax collections. The corporate side would have been a lot worse if it wasn’t for a huge recovery in the later part of the 2010 fiscal year.

The one interesting item is that the proxy for general consumption in the country, the Goods and Services tax, had a decrease of 0.2% year-to-year in revenues, so this is virtually unchanged. Similar to corporate income taxes, there was a huge surge in collections in the last part of the fiscal year.

On the expense side, government expenses were up approximately 17%. The bulk of this is attributable to the “economic action plan”, i.e. the stimulus package. The stimulus package, as projected in the 2009 budget, was approximately $23 billion, so one can infer that if it weren’t for the stimulus, the deficit would have been around $24 billion – a fairly manageable number.

Most notable is the 35% increase in Employment Insurance premium payments – mainly a function of increased unemployment, but also factored into this were government legislative efforts to enhance EI benefits for those that paid into the EI program for a lengthy period of time (7 years or over) receiving an extended amount of benefits.

My quick guess for 2010-2011 is that we will continue to see significant growth in revenues from the three main sources – personal income tax, corporate tax and GST collections in the 2010-2011 fiscal year. On the spending side, we will continue to see spending as well, and probably see a posted deficit of around $35-40 billion. This cannot continue indefinitely, otherwise Canada might face its own entitlement crisis. Although relative to other countries we are in better shape, we should be returning our fiscal balance to a mild surplus position and save some capital for future rainy days – which is more than likely to occur for the duration of this decade and beyond as the baby boomer generation retires.