Canadian Fiscal Monitor January 2010

This is about nine days late, but the Ministry of Finance released the fiscal results for the 10 months ended January 2010.

Of particular note is a massive increase in corporate income tax collections – up a whopping 74% for the month of January 2010, from January 2009. Although month-to-month results will be quite volatile in this category, for the 10 months from April 2008 to January 2009 and April 2009 to January 2010, corporate tax collections are still down 23%. This will inevitably be better in the 2010-2011 fiscal year.

The spending side of the ledger continues to be very high, with 12% growth for the 10 months to date.

Garth Turner on Variable/Fixed mortgages – bad advice

On Garth Turner’s “Bingo” post on March 29, 2010, he states:

But the big question I was asked today: what should you do about your mortgage?

The bankers will be on the phone to you soon ‘suggesting’ you lock in, ‘for your own protection.’ Have none of it, if you are in a cheap VRM. We know why the lenders are saying that, since they count on scores of people now rushing in to voluntarily increase their payments. Once again, they play the emotional card, consistently suggesting actions counter to the best interests of Canadians.

A prime-minus VRM is a gift. Keep it. The Bank of Canada rate would have to soar by more than 200 basis points (2%) by Christmas for you even to consider locking in. And even then you would be saving money staying variable. In fact, the typical prime minus one half borrower would be better off staying put until the prime mushroomed almost 4% above current levels. You’d still be paying less a month.

And a prime rate of 6.25% is not going to happen for two, three or perhaps four years. Any sooner and you could mop up the economy with a Swiffer.

Right now, a 5-year variable rate mortgage is prime minus 0.5%, and if you shop around, the 5-year fixed rate is 3.79%.

Prime is currently 2.25%, and should rise to 3.50% by the end of the year. Markets currently suggest the prime rate will be 4.75-5.00% at the end of 2011.

Thus, a variable rate mortgage, locked at prime minus 0.5%, should have a higher rate than a fixed rate mortgage sometime in the second half of 2011.

If prime stayed at 4.25% for the rest of the 5-year term, then a variable rate mortgage is still a cheaper option. However, the differential between the two is close enough that for most everyday people, I would still suggest a 5-year fixed rate if you can get 3.79% for it. It is highly likely over the 5-year period you will outperform the variable option, especially if the yield curve starts to invert (which will happen if the economic recovery runs out of steam).

The crystal ball becomes considerably more fuzzy if you use a 4.39% 5-year fixed rate (which is currently what is ING Direct’s posted rate). If rate increases in 2012-2014 moderate, then taking the variable rate option will be a winner. However, this is exceedingly difficult to predict.

Either way, the lack of ultra-cheap credit will have the effect of slowing down demand in the housing market. Whether that will translate into lower prices remains to be seen. Personally, I have long since thought the housing market was irrational beyond belief, but have come to accept it could be that way for longer than my lifespan.

Ultimately, the only time that housing will become “cheap” in Vancouver is likely when people don’t want to buy houses when mortgages are so expensive that GICs start to become an attractive investment option. Just imagine living back in 1982 when you had a choice of buying some Vancouver special for $150,000 on an 18% 5-year fixed-rate mortgage or renting and putting your would-be down payment in a GIC earning 15% and not having to worry about making those $27k/year interest payments… in situations like that, the cost of capital becomes so high that renting becomes a much more viable alternative.

If we ever see those days again, where buying a house is very difficult because you have such more financially attractive (and accessible) options elsewhere, I would suspect valuations are ripe for buying. We are a long way away from this, even if mortgage credit is given out at 5%.

Athabasca Oil Sands IPO valuation – summary

I am reading plenty of news how Athabasca Oil Sands is planning a very large public offering. According to their final prospectus, they will raise $1.35 billion @ $18/share of gross proceeds and about $1.26 billion net.

Since this got on the media’s radar, it should be a foregone conclusion that the option to purchase more of the offering will be exercised, so the final offering should be around $1.55 billion gross, and $1.45 billion net. The following analysis assumes the latter will be the case.

Note this is just a summary analysis. It only scratches the surface, but it covers what I figure are the salient details.

After the offering, they will have about 400 million shares outstanding, and assuming an $18 purchase price, this is a market capitalization of about $7.2 billion.

What exactly would an IPO subscriber be purchasing? This is why looking at the prospectus (all 288 pages in its full glory) is a valuable exercise. The company is a development stage company that has interests in a few tar sands near the Fort McMurray area of Alberta. They are currently not performing, but they are expected to come online in a few years, per the following schedule (page 8):

It would be reasonable for an investor to think this company will be producing net losses until around 2014-2015 when their oil sands projects come online.

After the offering, the company will have about $2 billion in the bank and about $400 million in long term debt. Thus, it will mostly be capitalized with equity and should have sufficient room to finish most of what they need to by 2014 – they will have to raise a little more money between now and then.

Page 78-84 of the prospectus contains some significant assumptions and analysis of the company’s estimated reserves. The first chart is based on a discounted net present value given the best estimates:

What this says is that if you have a 10% cost of capital and bought this company’s resources at the various sites for $11.2 billion, it would be a neutral decision. Of course, assumptions such as whether the company will be able to realize the “best estimate” or something better or worse is something for an investor to determine. Also, the following assumptions on future oil prices are made:

Roughly, it is assumed that (the media-quoted oil price source – there are different prices for different classes of oil) oil in 2010 will be US$80 in 2010; that the CDN/USD exchange will be 0.95, and that oil will increase $3/barrel until 2014, and then up 2% from there.

If projected oil prices are lower than this, you “lose” as an investor. If projected oil prices are higher, you “win”.

My quick take is that there are other companies out there using steam-assisted gravity drainage technologies to extract oil from tarsands. It takes a little (and I literally mean this; a little) research to figure out who those players are (beyond Suncor) and looking at their economic profiles. I can safely say that if I were offered shares of Athabasca Oil Sands at the IPO price, I would pass from a valuation perspective. From a market perspective, however, it would be worth considering strictly to sell it off at a post-IPO price. It kind of reminds me of the internet stocks in the late 90’s.

Once this company does go public it would not surprise me that they would get a valuation bump, and other similar companies that already are trading should receive bumps as a result. I have seen this already occur, probably in anticipation of the IPO.

If you had to invest into Athabasca Oil Sands and not anywhere else, I would find it extremely likely there will be a better opportunity to pick up shares post-IPO between now and 2014.

Posted bank mortgage rates irrelevant

I noticed there was a headline yesterday that a few of Canada’s major banks were raising posted rates on 5-year fixed rate mortgages from 5.25% to 5.85%.

This is completely irrelevant news. The reason is because posted rates are about as valid as the MSRP sticker price you see when you try and buy a new car – they will certainly sell it to you for that price and be very happy to make a bloated margin, but with some simple negotiation you can bat down the price to a more acceptable level.

I do not know why banks even bother with “posted” rates anymore – there must be a reason why they don’t post their most competitive rates. I am guessing it is because they don’t want to appear to be in direct price competition with each other.

Going to a mortgage broker or even looking at ING Direct’s site gives you a better reflection of what market reality is – it has not budged from 3.69% and 3.89% for a 5-year fixed term, respectively.

In reality, what happens is that the market establishes mortgage rates on a fixed spread over the 5-year government note rate:

The 5-year rate has hovered around 2.4% to 2.9% over the past 10 months; the 5-year fixed rate mortgage (at ING Direct) has hovered between 3.79% and 4.49% in the same timeframe.