Purchasing SPIA through Fidelity

[clifp]

To add to Brewers explanation of banking business. Roughly speaking for every $1 of deposits that Penfed gets it can lend out $10 in loans. So while some of the money Penfed will be loan will be at less than 5% a bunch will be at higher rate.

 

[Hamlet]

But aren't they paying an awful lot for that very small hedge?

It just seems very strange that they will lend money at a lower rate than they are willing to borrow it for with the same length of term.

Wouldn't originating a few less 10/1 ARMs accomplish much the same thing?

Let's pretend you are a lender, and a non-profit one at that. You have scads of savings and checking deposits sitting around that you pay almost nothing in interest to house. The cost of funds is great, but you also know that rates will eventually rise and you will have to pay more on these deposits. What you can invest in is a mix of floating rate (credit card, HELOC, etc.) receivables and fixed rate stuff (mortgages, car loans, etc.). The floating rate stuff is naturally matched with your savings accounts, as both tend to move in rates at the same time. Not so the fixed rate stuff. So you need to put on a portion of fixed rate longer term deposits to hedge your interest rate mismatch. You could go to Wall Street and either borrow money or pay up for derivatives to protect you, or you could just pay up in the deposit market and benefit your members (what you are supposed to do anyway). So you originate a bunch of 5/5 ARMs at 4% and you finance it with half floating rate deposits, 40% 3 to 5 year CDs at an average of 3% and 10% with long term CDSs at 5%. Cost of funds is roughly 1.7%. Voila, you have an interest margin of 2.3%, which should be more than enough to cover your overhead (which is modest because you run lean) and credit losses (which are miniscule because of your very tight underwriting standards and the fact that a large number of your borrowers are employed by the US Govt).

Or maybe you have lost your mind and just want to give money away before 2012 arrives and the Mayans turn out to be correct.

 

[Hamlet]

I don't think this is correct.

The way I understand it, a bank can lend out $10 in loans for each dollar of equity, not for each deposit dollar.

If it was true, when I deposit a dollar, where does the other $9 come from for them to loan out?

To add to Brewers explanation of banking business. Roughly speaking for every $1 of deposits that Penfed gets it can lend out $10 in loans. So while some of the money Penfed will be loan will be at less than 5% a bunch will be at higher rate.

 

[brewer12345]

But aren't they paying an awful lot for that very small hedge?

It just seems very strange that they will lend money at a lower rate than they are willing to borrow it for with the same length of term.

Wouldn't originating a few less 10/1 ARMs accomplish much the same thing?

They have to hedge the estimated duration of the asset with a similar combined duration of liabilities. If they can do that cost effectively by adding a slice of 10 year deposits even at a higher rate, then it makes sense.

As for the 10/1 ARM issue, mortgages prepay all the time, so actual duration of the asset is way less than the scheduled payments would suggest. People refinance, move for jobs, die, default, trade up, etc. long before the rate reset.

 

[brewer12345]

I don't think this is correct.

The way I understand it, a bank can lend out $10 in loans for each dollar of equity, not for each deposit dollar.

If it was true, when I deposit a dollar, where does the other $9 come from for them to loan out?

Correct: a dollar of equity can be multiplied, not a dollar of deposits.

 

[rayvt]

Hmmmm, I followed these steps and didn't see any promotional CD offer. OTOH, my current CD is at 5.25% and doesn't mature until 2015.