Key Post Are the lenders losing money on tracker mortgages?

[Brendan Burgess]

Bank of Ireland explains it very well as of June 2014.

Update March 2015:

Bank of Ireland's cost of funds was 1.03% in the second half of 2014.

Here are the figures for the other banks

AIB’s presentation


Slide 15: AIB’s cost of funds is 1.64%


[broken link removed] : Cost of funds: 1.65%

 

[Fin Crusader]

Tracker mortgages, as a standalone product, no matter what margin, actually make money for the banks, as they are set at a rate above the short term refinancing rate of the ECB. One can say that the banks are in part losing money due to residential loan defaulters but mostly their losses are due to defaults in the commercial loan sector which of course includes loans to buy commercial property. If a banks cost of funding is above this level, it is due to their bad lending practices, in particular with regard to commercial lending.

Presently the ECB is offering banks, including Irish banks, ultra low loans over a 4 year period ( a form of quantitive easing) in a bid to return the European economy to positive growth and try allay the spectre of deflation.

In relation to standard variable mortgage rates, if the course of action being adopted by the Irish Banks, in collusion with the Central Bank ( a bastion of consumer protection for the little man ) , of increasing variable interest rates when wholesale money market are decreasing, was taken by the banks in France or Italy their would be riots if not revolution on the streets. The Irish Banks are going for the low lying fruit on the tree, and there is no regulatory or consumer agency in this Country batting a eyelid- shame on ye.

 

[Lightning]

Tracker mortgages, no matter what margin, actually make money for the banks, as they are set at a rate above the short term refinancing rate of the ECB.

A banks financing rate seldom equates to the ECB repo rate. Irish banks main source of funds is deposits. Deposits, on average, pay a rate above the ECB repo rate.

In addition, obviously, default costs and admin costs sit on top of the banks financing rate.

That said, as deposit rates decline, and trackers get repaid on average at a rather speedy rate, banks are not making as a big a loss as they once did with trackers.

Presently the ECB is offering banks, including Irish banks, ultra low loans over a 4 year period ( a form of quantitive easing) in a bid to return the European economy to positive growth and try allay the spectre of deflation.

The take up was dreadful for TLTRO. Very few banks were interested. A tiny percentage of funding is coming from TLTRO.

 

[Fin Crusader]

Have to disagree with you, in normal times your statement would be true, however in banking terms we are still living in extraordinary times. Irish banks main source of funding presently is ultra low direct Central Bank funding. Deposits at present are not making much money for the banks, indeed the ECB is charging negative rates for overnight deposits from banks. Capital gearing ratios have changed for all banks in Europe due to ECB stress testing and new rules on tier 1 and 11 capital ratios, so a larger proportion of the deposits held by banks just sit there or are put into convertable government bonds. Recently there has been some return to normality within the banking system with regard to the secured and unsecured bond market and indeed the increase in foreign funding. In relation To TLTRO uptake, yes this uptake was not good as most of the Irish banks had already satisfied their medium term funding obligations.

 

[Lightning]

Irish banks main source of funding presently is ultra low direct Central Bank funding.

A few years ago, banks main source of funds, in some cases, was ECB ELA, ECB LTRO and CBI liquidity. Not any more.

For example, have a look at the BoI 2013 results here: https://www.google.ie/url?sa=t&sour...yjUWSK7kVrW7wO41g&sig2=4oa8Ov3Z1AA6CsY4IXYAdg

As per the BoI results, and AIB results, the main source of funding is deposits. Deposits significantly outweigh monetary authority support.

The trend continues, at a rapid pace, away from monetary funding support and back towards traditional depository funding.

 

[Sarenco]

Thanks for that Brendan.

Bank of Ireland's cost of funds actually fell to 1.03% by year-end so the net interest margin from their tracker book moved decisively into positive territory. This trend has obviously continued into the first quarter of 2015.

 

[Dermot]

Thanks for that Brendan.

Bank of Ireland's cost of funds actually fell to 1.03% by year-end so the net interest margin from their tracker book moved decisively into positive territory. This trend has obviously continued into the first quarter of 2015.

Would not be sure that. I have investment trackers at less than 1% and had I been taking out a home loan tracker at the time it would be costing me 0.7% now. We would need to know what their overall average tracker rate is before we could make a judgement. There is also an administrative cost to be taken account of as well.

 

[Sarenco]

Would not be sure that. I have investment trackers at less than 1% and had I been taking out a home loan tracker at the time it would be costing me 0.7% now. We would need to know what their overall average tracker rate is before we could make a judgement. There is also an administrative cost to be taken account of as well.

Hi Dermot

The average spread over the ECB rate (1.05%) is actually set out in the above chart.

The cost of funds is simply the interest rate that a financial institution has to pay to borrow funds that they deploy in their business. Servicing costs are a separate matter.

 

[Dermot]

So BoI are breaking even on the Tracker Rates of those that are repaying but would they be losing overall given that all trackers are not performing or is that an incorrect interpretation of the figures in the above charts. I am not good on the technical jargon.

Given that PTSB & AiB's average cost of funds are higher and probably at a lower average tracker rate as they were more aggressive in the tracker market than BoI they would be making a loss on their tracker book.

Servicing costs are a separate matter.

Nevertheless they have to be included in order to give a valid picture of their mortgage book

 

[Sarenco]

Well at this stage Bank of Ireland are actually doing somewhat better than breaking even on their trackers.

Impairment charges on defaulting loans (including trackers) go to profitability but my point is really to dispute the oft repeated assertion that SVRs are high because banks are subsidising loss making trackers.

As far as I know, neither AIB nor PTSB break out their figures on trackers in this way. Their cost of funds is somewhat higher than BoI but has fallen rapidly over the last 6 months so I think it is reasonable to assume that at this stage the net interest margin from their tracker books is broadly neutral.

 

[Sarenco]

[broken link removed]

Hi Brendan

I took it from page 12 of the attached investor presentation on the year-end results.

 

[Sarenco]

[broken link removed]

Hi Brendan

AIB's cost of funds actually fell to 1.57% by year-end 2014 (I believe this figure reflects the average over the full reporting period) - see page 16 of the attached presentation.

AIB made significant cuts to deposit rates in the first quarter of 2015 so this figure almost certainly overstates their current cost of funds to a material extent.

 

[Sarenco]

http://www.permanenttsbgroup.ie/~/m...entations/2015-analyst-and-investor-pres.pdf?

PTSB's core cost of funds by year-end 2014 was 1.17% and the average tracker rate was 1.16% (ECB repo rate plus 1.11% spread) as per the attached year-end presentation.

PTSB slashed their deposit rates in the first quarter of 2015 and with fixed-term deposits at much higher rates continuing to mature, their cost of funds would be very significantly lower today.

Putting it all together, I think we can say with some confidence that banks are no longer losing money on trackers.

 

[Brendan Burgess]

Putting it all together, I think we can say with some confidence that banks are no longer losing money on trackers.

Your confidence is completely misplaced.

They are not losing as much as they were, but they are still losing money.

How do you think that they pay the costs of running the banks?

Brendan

 

[Sarenco]

Your confidence is completely misplaced.

They are not losing as much as they were, but they are still losing money.

How do you think that they pay the costs of running the banks?

Brendan

Sorry Brendan but could you clarify whether you are disagreeing with my conclusion that our banks' cost of funds is now, in all probability, lower than average tracker rates? That has been the basis of the discussion to date.

The net interest margin on their tracker books is how the banks themselves describe the impact of these loan books. Obviously operating expenses and impairment charges in general are highly relevant to the profitability of a lender but that's not the point under discussion.

In any event, I would suggest that the costs of servicing a back book of performing tracker mortgages is negligible. The cost of servicing (and the impairment charges associated with) non-performing loans (including trackers) is obviously very significant and that's really my broader point.

 

[Brendan Burgess]

Hi Sarenco

I am getting ready to speak at ptsb's AGM tomorrow, so that document and your analysis is very interesting.

I have extracted the two pages relating to ptsb's cost of funds on the attached.

There current group cost of funds is 1.44% while their core bank cost of funds is 1.17%. It seems that the reason for the higher group cost is due to a higher cost of funds in the UK, so let's just take the core cost of funds as 1.17% as it probably relates best to trackers. The tracker yield is 1.3%, so they are making a margin on the tracker book before admin costs.

However, I am a bit confused, as the 4th page on the attached shows a net interest margin of -0.3%? They are using the group cost of funds, and not the core cost of funds.

In any event, they are not losing as much as I thought they were.

But, are they losing money at all?

Here are the figures from the presentation

Let's say that the ECB bought all the trackers from ptsb at their nominal value.

The interest received less interest paid would not change.

They have €15 billion of trackers and €8.5 billion of variable rates. If they lost 63% of their loans, I suspect that their admin and staff expenses would fall significantly. Not by 63% but maybe by 30% - say €100m.

Likewise, if ptsb could increase the rate on trackers by 1%, they would be back in profits.

But it's probably not worth their while giving people a big discount to pay off their trackers early.

 

[Brendan Burgess]

the impairment charges associated with non-performing loans (including trackers) is obviously very significant

Oddly enough, I don't think it is any more. I would guess that they have way over-provided for their losses on non-performing loans. This year they wrote back some of the provision.

So, the tracker book could become a source of further write-backs, i.e. increased profits.

 

[Bronte]

There current group cost of funds is 1.44% while their core bank cost of funds is 1.17%. It seems that the reason for the higher group cost is due to a higher cost of funds in the UK, so let's just take the core cost of funds as 1.17% as it probably relates best to trackers. The tracker yield is 1.3%, so they are making a margin on the tracker book before admin costs.

However, I am a bit confused, as the 4th page on the attached shows a net interest margin of -0.3%? They are using the group cost of funds, and not the core cost of funds.

In any event, they are not losing as much as I thought they were.

But, are they losing money at all?

In relation to the UK and cost of funds. I have a loan with Ulster for an Investment property. How much I pay is based on the banks costs of funds plus a margin. The costs of funds changes every two weeks. Every year I get an annual statement showing the changes for each two weeks. Is this a different cost of funds, to the cost to the banks for mortgages. The rate went as low as .6% at some stages.

The margin is set at the beginning of the loan and does not change. It has meant that the loan is a lot less expensive than the current variable rate Ulster charges.

 

[Sarenco]

Hi Sarenco

I am getting ready to speak at ptsb's AGM tomorrow, so that document and your analysis is very interesting.

I have extracted the two pages relating to ptsb's cost of funds on the attached.

There current group cost of funds is 1.44% while their core bank cost of funds is 1.17%. It seems that the reason for the higher group cost is due to a higher cost of funds in the UK, so let's just take the core cost of funds as 1.17% as it probably relates best to trackers. The tracker yield is 1.3%, so they are making a margin on the tracker book before admin costs.

However, I am a bit confused, as the 4th page on the attached shows a net interest margin of -0.3%? They are using the group cost of funds, and not the core cost of funds.

In any event, they are not losing as much as I thought they were.

But, are they losing money at all?

Here are the figures from the presentation

View attachment 474

Let's say that the ECB bought all the trackers from ptsb at their nominal value.

The interest received less interest paid would not change.

They have €15 billion of trackers and €8.5 billion of variable rates. If they lost 63% of their loans, I suspect that their admin and staff expenses would fall significantly. Not by 63% but maybe by 30% - say €100m.

Likewise, if ptsb could increase the rate on trackers by 1%, they would be back in profits.

But it's probably not worth their while giving people a big discount to pay off their trackers early.

Hi Brendan

On the basis of the presentation itself, 1.44% is the period average figure for H2 2014, whereas 1.17% represents the actual cost of funds at year-end. The 1.57% figure represents the average cost of funds for 2014 as a whole.

I strongly suspect that the 1.17% figure materially overstates PTSB's current cost of funds, given the very significant cuts to their deposit rates last month. I wouldn't be at all surprised if PTSB's cost of funds at the end of the last quarter (Q1 2015) fell below 1% - it could now, perhaps, even be as low as 80bps.

On the other side of the equation, I believe the tracker rate of 1.27% represents the average rate paid by customers over 2014, whereas the current rate is 1.16% (ECB repo rate plus 1.11% average spread). The figure of 1.3% reflects the average gross income on trackers expressed as a % of the average balance on tracker mortgages outstanding over 2014 as a whole.

I would suggest that the number of employees/man hours that are required to service the back book of performing trackers is very low.

 

[Sarenco]

They have €15 billion of trackers and €8.5 billion of variable rates. If they lost 63% of their loans, I suspect that their admin and staff expenses would fall significantly. Not by 63% but maybe by 30% - say €100m.

[broken link removed]

I have been trying to put some (very) rough figures on what it might cost to service an existing book of tracker mortgages.

I can't find any relevant data from this side of the world but the attached note from Accenture in 2014 suggests that the average annual cost of servicing an existing mortgage book in the US is just over $200 per loan. Intuitively this figure seems about right given the degree of automation involved and, if it corresponds to the cost of servicing mortgages in Ireland, that equates to 0.1% on a €200,000 loan, (which is (very) roughly the outstanding balance on an average tracker mortgage judging by IBF figures).

I would emphasise the "back of an envelope" nature of the above but, if broadly correct, it would tend to suggest that the average cost of funds of our lenders plus servicing costs are, in all likelihood, lower than average tracker rates.