Are Banks Milking Variable-rate Holders?

Prime – 1.00% is a primo mortgage rate. No question about it.

Yet, there are people complaining that it’s not the “prime minus one” of old.

Prior to January 2015, critics point out, prime rate was 200 basis points (bps) above the Bank of Canada’s key lending rate. Now, banks have pushed this margin to 220 bps. The fatter this spread goes, the more banks make (other things equal).

So far, all of this is true, of course. Back in 2015 Canada’s opportunistic banks pocketed 40% of the BoC’s rate cuts. That, say critics, results in banks making more on variable rates today — on the backs of Canadian consumers.

Spreads Tell a Truer Tale

If only we knew the difference between the average variable rate and the big banks’ cost of funds. Then we’d be able to tell if borrowers are being gouged or not.

Well, lo and behold, we do.

And they’re not.

Observe the “Variable-BA Spread,” which refers to the difference between:

A)  the average variable mortgage rate

and

B)  the 3-month bankers’ acceptance (BA) yield.

(Three-month BAs are a rough proxy for the big banks’ basic variable-rate funding costs.)

Using today’s rates as an example, the 3-month BA is currently 1.69%. If a big bank offers you prime – 1.00% (i.e., 2.45%), it’s making roughly 0.76 percentage points (76 bps) of spread on your mortgage.

That, of course, is before the bank pays its staff, covers overhead and incurs a range of other costs.

Spreads Are Narrowing

The chart below counters the popular diatribe that banks are gargantuan money-grubbing profiteers that pass along savings, like, never.

The reality is, banks have steadily earned less and less on variable-rate mortgages for six years running. In fact, they’re earning less on deep-discounted variables today than they have for over a decade (as far back as our data goes).

The key words are “deep discounted.” Banks don’t offer their best rates to everyone. In this context, “deep discounted” refers to insured and uninsured discretionary rates offered to well-qualified borrowers and variable rates sold by non-bank lenders using bank funding.

The Forces Are Aligning

Note the steeper drop in spread revenue over the past year or so. In that time-span, bank competition has shifted to a higher gear.

We’re seeing:

• Online-savvy competitors (e.g., HSBC, Meridian Credit Union, etc.) give it to the banks
• Mortgage brokers increasingly buy down rates
• Rising rates, high home prices and regulatory restrictions pushing mortgage growth to 17-year lows
• Rates are rising (which gives banks more spread to work with), and
• More people using rate comparison websites.

The mortgage consumer is growing smarter every year. Thanks to Google-power, people can now log into sites like this and tell in seconds if their bank is hosing them on their rate.

That isn’t banner news for banks who must eat into net interest margins to keep pace of competitors. But it’s sure as heck great news for Joe Consumer. And all that good news is translating into record savings on big bank variable rates.