Profit margins for lending institutions

[laurence]

Caveat, haven't done a lot of research on this but:

A couple years back when rates were at their low, you had to kill yourself to get more than 1% on a savings account, yet 30 year mortgages were still in the 5%+ range. Now you can get 5% or close to it just about anywhere with your money, yet mortgage rates are just a little over 6%. Like we all learned in "It's a wonderful life" the bank makes money on the spread, and that spread is shrinking. Now I know I'm vastly simplifying here, but along with lending institions resorting to more sub-prime lending, anybody else out there short on this industry? We've beat to death the whole forclosure risk thing here, but even loans that don't go bad aren't the revenue generators they once were, so there is less to absorb the increasing bad loans, right? Is this tied into the inverting yeild curve Brewer pointed out - i.e. a ramification of?

 

[brewer12345]

Most banks have had their spreads squeezed. That means that the difference between earned interest and paid interest has contracted. But its not as severe as you might think because the average bank can't/won't hold 15 or 30 year fixed mortgages. They will typically sell of the fixed loans to investors and keep ARMs, 3/1s and 5/1s in the prime world, and all maner of floating and hybrid subprime loans. They can't afford to borrow short and lend long - too many institutions have gotten blown up that way.

There are also a lot of sources of low cost funds for banks. Think about it: checking accounts, passbook savings, etc. There are millions of people who play the lottery - wanna bet they aren't too vigilant about the interest rate on their account?

So yeah, its been a crappy couple of years for traditional "Its a Wonderful Life" type banks, but they have muddled through. The ones that may find themselves in troouble are those that greatly expanded their mortgage holdings in bubble markets by loosening lending standards. If there is a foreclosure wave, the guys with lilly-white borrowers will feel a slight tingle, but that's about it. OTOH, if there is no collapse and default tsunami, then the guys with loans to risky borrowers will make more money because they charge higher rates.

 

[mathjak107]

dont forget paying you 5-1/2% and loaning it out at 6-1/2 % is a pretty good profit margin ,18% in fact

 

[d]

"prime" exceeds 8%, and credit card rates are often in the 18% vicinity ... i wouldn't worry too much about the banks.

 

[laurence]

Yeah, I guess they ain't making their money on the likes of us!

 

[Martha]

Banks also make mortgage money on orgination and selling mortgages. Who cares what the rate is.

They also buy pieces of commercial loans and leases, which are almost always fixed at most for a short period and often variable rate loans.

They make money on commercial deposits too. Often they require their commercial loan customers to maintain accounts at the bank.

 

[crazy connie]

Not to mention the payday loan places are owned by the big boys. And let someone slip on a card payment and discover 30% annual rate. Credit Card Nation is one of my all time favorite books. I just spotted it in the bookcase yesterday and need to surf it once again.

 

[Texas Proud]

Banks own very little mortgage... they package them quickly...

In fact, they package most of their loans, car, credit card, corporate... it is the FEES that they want and a 25 bp on everything they package..

Also, there are very sophisticated programs balancing thier gaps...

Finally, a bank (at least they used to) make about 3% spread, not 1%...

 

[Cool Dood]

Yeah, I guess they ain't making their money on the likes of us!

Sometimes I worry that they have a computer program that will happen upon my account one night and alert the bank that they're not making much money from me, that they'll probably only break even after all my future years of being a client, and they'll have some nasty surprise in store for clients like me who don't provide the constant stream of fees, overdue credit card payments, etc.

I just hope it's more along the lines of a nasty letter than the Rack...

 

[free4now]

When I take a mortgage out the lender expects that loan to last approx 5 years (my guess), and the rate won't change over that time (except when variable loans adjust). The savings account rates change week by week and even day by day, so they don't include any real predictions of where things are heading.

I think the short/long term difference is the main reason why the savings versus mortgage rate spreads have changed. As the yield curve changes shape, the spread between mortgage and savings accounts will naturally change.

The idea we learned in school that banks simply loan out their savings account money to finance mortgage loans is so much of an oversimplification that it doesn't really help in understanding how things actually work. In reality the banks usually sell off mortgage loans to investors so the only reason they care about the mortgage rates is to make sure the loans they write are saleable.

And there are lots of hedging strategies that tend to reduce the exposure banks have to interest rate fluctuations.

 

[brewer12345]

The idea we learned in school that banks simply loan out their savings account money to finance mortgage loans is so much of an oversimplification that it doesn't really help in understanding how things actually work.  In reality the banks usually sell off mortgage loans to investors so the only reason they care about the mortgage rates is to make sure the loans they write are saleable.

It depends on the bank. SOme originate mortgages and sell them, others originate and hold them. Still others do a bit of both. You really have to look at an individual bak to see what flavor they are.

 

[laurence]

The 3 mortgages I've had (One to purchase, 2 refis) were through 3 different lenders, and they all got sold to Countrywide!

 

[Mach1]

Here is an example: I took out a business line of credit for 850K a couple years ago, the terms is prime + 1/4, back then the monthly interest payment was around 3K, which isn't bad. Today, I just wrote them a check for $6340 for this month. Yikes!!!

 

[Donzo]

Credit cards a the huge windfall for banks and they compete aggressively. I get at least 3 offers for credit cards every week. This competition is good - I have one credit card that gives me United miles - I use it alot and pay it off each month. They charge $60 per year. All I do each year when I see the $60 charge show up on my statement is give them a call and tell them that if they don't take off the charge I am going to switch - they take it right off.
I don't know what proportion CC income is for the average bank - but it has to be its most profitable sector.

 

[laurence]

All I do each year when I see the $60 charge show up on my statement  is give them a call and tell them that if they don't take off the charge I am going to switch - they take it right off.

Hey! That's a good tip! I've seen cards I'd be interested in, but the annual fee was a deal killer. Good info!

 

[Scrooge]

Yeah, I guess they ain't making their money on the likes of us! 

Probably not, at least judging by my experience with the bank that I have my checking account with. At one point I also had a savings account with them, but with the rise of high yield internet based MMAs, the local guys couldn't or wouldn't stay competitive. So I transfered all of my money to HSBC/Emigrant and eventually there was no point in keeping the old savings account, which had a grand total of $3k left in it, around.

I went to the bank on a Saturday morning and asked them to close the savings account. They didn't seem to be very happy about it, presumably because they could see that at one point I had almost $100k there and now the gravy train was about to come to an end. They made me a number of offers, but all of them were misleading, e.g. "But our CDs pay more than internet MMAs!" I suppose any customer who falls for this trick gets what he deserves

 

[maddythebeagle]

And there are lots of hedging strategies that tend to reduce the exposure banks have to interest rate fluctuations.

good point...my sister was a mortage analyst/trader for several years and I follow a few midwest banks....and the ones that dont hedge...I think Annaly was one (brewer probably would know about them ), got crunched a bit a ways back.

Considering all of the folks with helocs, etc., I would say that the banks should do quite nicely....

 

[brewer12345]

Hedging is great if you can reliably do it right. Mortgages can be hard to hedge when rates move around a lot, so many banks don't want to hold fixed rate mortgages. That's one of the reason ARMs are so popular: it is easier for the bank to hedge, so they are willing to reduce the spread they charge.

 

[Texas Proud]

The 3 mortgages I've had (One to purchase, 2 refis) were through 3 different lenders, and they all got sold to Countrywide! 

Actually, no... the servicing of your loan got sold to Countrywide.... the people who send you the bill and screw you on your escrow are rarely the people who you owe the money..

There is not much worry on the rates... the banks get commitments from investors before they make the loan (most of the time)... that is why you can get a 30 day lock.. the financing is already there...they just need to get about a billion or more dollars in loans and package them up..

 

[FinanceDude]

I worked at Chase a while back. Banks don't make 3% on average spread. Real spread is about 150 bp on average, between credit cards, savings, loans, etc. Some areas of the bank are higher margin than others.

When interest rates are higher, banks get squeezed. However, they MORE than make up for it, when rates drop.

 

[Hamlet]

The type of interest rate environment we are currently in has historically been bad for banks, for the reasons you mention.  

One thing that is helping banks this time around is that they are much more diversified in their income streams.  Most of the banks now get a large portion of their income from fees, rather than just living off the spread.  So while the reduction of their interest spread has been a drag on earnings, it hasn't been dramatic.

Take TCF (ticker TCB), a Minneapolis based bank that I own stock in.  Their earnings per share were down slightly last quarter, but it was pretty minor.  Eventually the spread will get back to normal, and their earnings will start increasing again (knock on wood).

I think the market has been pretty rational in valuing most of the bank stocks I look at.  In fact, I think the sector as a whole should give decent returns over the next 5 years or so.  

Caveat, haven't done a lot of research on this but:

A couple years back when rates were at their low, you had to kill yourself to get more than 1% on a savings account, yet 30 year mortgages were still in the 5%+ range.  Now you can get 5% or close to it just about anywhere with your money, yet mortgage rates are just a little over 6%.  Like we all learned in "It's a wonderful life" the bank makes money on the spread, and that spread is shrinking.  Now I know I'm vastly simplifying here, but along with lending institions resorting to more sub-prime lending, anybody else out there short on this industry?  We've beat to death the whole forclosure risk thing here, but even loans that don't go bad aren't the revenue generators they once were, so there is less to absorb the increasing bad loans, right?  Is this tied into the inverting yeild curve Brewer pointed out - i.e. a ramification of?

 

[Arif]

When interest rates are higher, banks get squeezed. However, they MORE than make up for it, when rates drop.

It's weird watching the mortgage rate decline these last four weeks even though interest rates have been increasing. I guess that is the supply and demand part of the equation.

 

[CCdaCE]

I heard another big money maker for banks like Wells Fargo is FEES.

$1 to check last 10 transactions in your checking acct., at an ATM. $33 for a bounced check or some ungodly amount. etc. etc.

They figured they can make big cash at "nickling and diming". Is that an infinitive profit for checking the last 10 transactions?

Another thing banks don't do, is don't provide you a big sheet of paper for each transaction. You get this little receipt, like the grocery store. They've cut costs. Hire fewer tellers, and make you fill out the deposit/withdrawal slip.

-CC

 

[Texas Proud]

I worked at Chase a while back.  Banks don't make 3% on average spread.  Real spread is about 150 bp on average, between credit cards, savings, loans, etc.  Some areas of the bank are higher margin than others.

When interest rates are higher, banks get squeezed.  However, they MORE than make up for it, when rates drop.

I will revise my statement... banks CHARGE a 3% premium.. or should I say want to charge that premium... the PROFIT they make is between 1% to 1.5% on assets...

Right now the bank is paying .2% for MM accounts.... the longer term CD is around 5 to 5.5... the loan rate is in the 8 to 8.5% range.. or higher..

 

[mathjak107]

remember we are talking gross profit margins....a bank that borrows from you at say 4% and loans it at 6% isnt making 2% profit,they are making 33% profit