What Changing Interest Rates Mean for ONE HISA

Posted: June 20, 2018
Tagged As: Asset Management, Investments

Note: This text was originally written in May 2018, and the charts and information within are reflective of that time period.

After three consecutive rate increases to the Bank of Canada’s Prime interest rate, you may have noticed a number banks and other financial institutions offering some aggressive interest rates on their products.  In some cases, these offers exceed the current effective rate paid by the ONE Investment Program’s High Interest Savings Account (HISA). While it remains a competitive market place for these funds, there are some subtle differences between these offers and the ONE HISA that warrant some explanation. 
 
Currently, the ONE HISA pays a floating interest rate indexed to the Bank Prime Rate (currently 3.45%) less 1.535%.  This gives the HISA an effective rate of 1.915% (3.45% - 1.535%). The benefit of this arrangement is that as interest rates rise, so too will the rate paid on your deposit. Bank Prime has historically moved in line with changes in the Bank of Canada’s Overnight rate. Since the inception of the HISA in 2015, the Bank of Canada has cut rates twice by 0.25%, but the Bank Prime Rate only declined by 0.15% each time. The result is that since that time, participating members received an additional 0.20% versus deposits options indexed to other market rates.
 
Recently the Bank of Canada began hiking rates.  First in July of 2017, then again in Sept 2017, and most recently in January 2018.  Each time Bank Prime rose by 0.25%, for a total increase of 0.75%. Correspondingly, the rate paid on the HISA has risen in lock step, and is now 0.75% higher than it was this time last year.
 
So what does this have to do with these aggressive offers seen from Banks and other financial institutions? In our experience, these new offers tend not to be indexed to an impartial rate like the Bank Prime Rate. Instead, they are indexed to an internal “reference rate” unique to the Bank or financial institution, with little or no information available on how it will behave going forward. Since the organizations offering these products have historically indexed their non-personal deposit accounts to the Prime Rate, we are left to wonder just why they have decided to make the switch to this new undefined reference rate. Our expectation is that as the Bank of Canada raises interest rates rise over time, investors in these accounts will not benefit from an equal hike in rates of 0.25% each time.
 
The potential to lag future rate hikes even by a small amount can be material. Below are the most recent (as of May 1st) Bank of Canada Overnight Rate forecasts of the big five Canadian Banks.
 
Graph of Canadian Big Five Banks Overnight Rate Forecasts
  Date of Forecast May-18 Q2 18 Q3 18 Q4 18 Q1 19 Q2 19 Q3 19 Q4 19
CIBC April 30th 1.25% 1.25% 1.50% 1.50% 1.75% 1.75% 2.00% 2.00%
RBC April 6th 1.25% 1.50% 1.75% 2.00% 2.25% 2.25% 2.25% 2.25%
BMO April 5th 1.25% 1.25% 1.50% 1.75% 2.00% 2.25% 2.50% 2.50%
BNS April 12th 1.25% 1.25% 1.50% 1.75% 2.00% 2.25% 2.25% 2.50%
TD March 14th 1.25% 1.25% 1.50% 1.50% 1.75% 1.75% 2.00% 2.00%
Median Expectation 1.25% 1.25% 1.50% 1.75% 2.00% 2.25% 2.25% 2.25%

As the table and chart above shows, all of the big five Canadian Banks believe the Bank of Canada will increase interest rates over the next couple of years. CIBC and TD seem to have the most conservative approach, expecting the next hike to occur sometime in Q3 2018 (CIBC believes it will be on July 11th). Following that, both banks do not expect another hike until Q1 2019. By comparison, RBC had the most aggressive near term forecasts, predicting a Bank of Canada increase before the end of June 2018, but have since amended their forecast. However, the table still references the rate from May 1, 2018 that assumes the hike would occur. The difference in the expected timing and frequency will ultimately determine what you may earn on a floating rate solution like the ONE Investment HISA, or the reference rate alternative.
 
Using the Bank of Canada rate forecasts provided above, we have estimated the return the HISA would provide over the next 3-months, 6-months, one-year, and two-year terms, beginning May 1, 2018.  This assumes that the HISA will mirror the Bank of Canada rate increases over those periods as it has in the past.
 
Potential Equivalent Term Rates Available in the PIA Based on the Forecasts
  3-mth 6-mth 1-yr 2-yr
CIBC 1.97% 2.08% 2.19% 2.40%
RBC 2.14% 2.27% 2.53% 2.74%
BMO 1.97% 2.08% 2.30% 2.71%
BNS 1.93% 2.00% 2.22% 2.62%
TD 1.93% 2.00% 2.12% 2.36%
*Annualized. Due to mathimatical rounding they represented close approximations 
*Interest is paid mthly. Rates are calculated to include this mthly compounding
*Assumes forecast remains unchanged if it doesn't extend 2 full years
*Assumes rate changes occur mid-quarter unless specified in the forecast (CIBC & BMO)
 
If we perform the same calculations that generated the estimated term returns above, but assumed the other Banks’ “Reference Rate” would only rise 0.15% compared to the Bank of Canada’s 0.25%, you can see the impact of in the table below.
 
Approximate Equivalent Term Rates of ONE HISA Based on Above Forecasts
  3-mth 6-mth 1-yr 2-yr
CIBC 1.96% 2.02% 2.08% 2.22%
RBC 2.06% 2.14% 2.29% 2.42%
BMO 1.96% 2.02% 2.15% 2.40%
BNS 1.93% 1.97% 2.10% 2.34%
TD 1.93% 1.97% 2.05% 2.19%
*Annualized. Due to mathimatical rounding they represented close approximations 
*Interest is paid mthly. Rates are calculated to include this mthly compounding
*Assumes forecast remains unchanged if it doesn't extend 2 full years
*Assumes rate changes occur mid-quarter unless specified in the forecast (CIBC & BMO)

As you can see a “Reference Rate” not directly indexed to a measurable / trackable / independent benchmark rate could result in a significant reduction in the potential rate of return on an alternative deposit account when compared to the potential rate of return that could be achieved via the ONE Investment HISA.
 
David N. Black is a National Deposit Specialist Director of Corporate & Commerical Banking for CIBC, the Program Partner for the ONE HISA offering.  Should you have any quetions about the above or the ONE HISA, you can contact David directly.

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