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14 Mortgage Margins
Mortgage margins
The correlation between mortgage rates and the repo rate has decreased
due to the higher funding costs banks have faced since the 2008 international
financial crisis. Tighter new regulations, which Swedbank has welcomed, further
increase the cost of a mortgage for both the bank and for customers.
A debate is under way in the media on how banks set their
lending rates and how large their margins are on mortgages,
for example. A lot of attention has been drawn to the fact that
the interest rates customers pay on their mortgages are not
always lowered when the Riksbank cuts its repo rate. It has
also been said that mortgage rates generally seem higher in
relation to both the repo rate and the interbank rate (STIBOR)
now than before the financial crisis.
also means that a change in the repo rate has only a limited
effect on the banks’ funding cost and hence on the mortgage
rates they charge.
One reason for this is that covered bond investors require
the banks to post collateral for their funding in excess of the
loan amount (so-called over-collateralisation). This protects
them against the risk that the collateral will be insufficient if
housing prices fall substantially.
Banks’ total funding costs have increased more than
the repo rate
The diagram on the following page shows that the three-month
Stockholm Interbank Offered Rate (STIBOR), the rate at which
a well-managed bank can obtain short-term deposits from
other banks in the interbank market, was slightly above the
Riksbank’s repo rate, which is a day-to-day rate, until mid-2007.
After that the difference between the repo rate and STIBOR
rose due to growing suspicions between banks in connection
with the subprime crisis in the US and widened during the
2008 global financial crisis. A bank can never fund its lending
in the Riksbank and in the long run not in the interbank market
either. On the other hand, until the financial crisis in 2008 it
could issue bonds – covered or unsecured – at interest rates
largely corresponding to STIBOR. But after STIBOR gradually
climbed above the repo rate, the cost of market funding – a
bank’s actual funding cost – rose faster than the repo rate until
the financial crisis culminated in autumn 2008.
In its report, the Riksbank confirms that the banks are
not funding their lending at a cost that corresponds
to the repo rate
The diagram on the next page is similar to the one published
twice a year in the Riksbank’s Financial Stability Report. In its
autumn 2011 report, the Riksbank states: “A common misconception is that the banks borrow money at a cost equivalent to
the repo rate. The chart shows, however, that additional costs
arise when the banks acquire funding. To fund mortgages, the
banks usually issue covered bonds at a fixed rate and with a
maturity of up to five years. This led to an increase in the cost
of funding a mortgage compared to the interbank rate. The red,
yellow and grey fields have thus together contributed to an
increase in the banks’ total funding costs.”
Swedbank funds its lending primarily
through covered bonds
Since 2009 the large percentage of mortgages granted by the
banks must be funded by issuing covered bonds. They are in
themselves a beneficial and efficient form of refinancing for
banks that can use them, since they give the banks’ own lenders
access to the collateral that the banks receive from mortgage
borrowers. As evident in the diagram, this has not prevented
the cost of covered bonds to remain at a higher rate than
STIBOR since the financial crisis in 2008. As a consequence, the
banks’ funding costs fell significantly less in 2009 than interest
rates in general and have since remained above STIBOR. This
Swedbank Annual Report 2011
Deposits help to keep mortgage rates down
The more collateral relative to the funding amount that
investors require to buy covered bonds, the larger the share
of its mortgage volume a bank must refinance through ways
other than covered bonds. One alternative is to issue senior
unsecured bonds. This makes the refinancing of mortgages
even more expensive, since investors require an even higher
interest rate to buy such bonds. Swedbank can keep funding
costs down, however, by using a portion of its deposits from
companies and households to partially fund its mortgages.
It does just that, because of which the grey field in Swedbank’s
diagram is thinner than for certain other banks. Consequently,
the funding rate that our branches base their mortgage rates
on is slightly lower than they would otherwise be if so many
savers did not put their money into the bank.
Mortgage Margins
The blue field in the diagram shows the bank’s gross margin
The upper blue field in the diagram represents Swedbank’s
gross margin on mortgages. This field shows the difference
between the average interest rate on three-month mortgages
that the bank charges borrowers and its funding cost based on
covered bonds, deposits and senior unsecured funding. The
diagram shows how the margin, which was well over one per
cent in the early 2000s, gradually decreased until the financial
crisis. The gross margin was nearly nil during the financial
crisis, but has increased again since they bank has been able
to normalise its funding terms. From summer 2009 to summer
2011, when the funding markets were generally working
normally, the average gross margin fluctuated between
approximately 0.3 and 0.5 per cent.
Tighter new regulations are increasing costs
for banks and for customers
In recent years a number of tighter regulations have been
discussed and introduced for banks, which we welcomed and
feel are a prerequisite for creating a more stable financial
sector in the future. The biggest effect on costs is expected
to come from the new liquidity rules. They require a bank to
ensure that it can continuously fund a long-term mortgage
portfolio even if its ability to raise new refinancing loans is
closed for shorter or longer periods, as was the case during
the financial crisis. This cost of liquidity protection can at times
amount to 0.5 per cent, but in normal market conditions is
closer to 0.2–0.3 per cent. This cost must be covered by the
bank’s gross margin on mortgages.
The bank must also expect that some borrowers, despite
careful credit checks, cannot fully pay the interest and principal
15
on their mortgages. The bank estimates that credit impairments
over time will amount to three hundreds of a per cent (3 bp).
According to current capital adequacy rules, the bank must at
the same time maintain risk-bearing capital, mainly shareholders’
equity, as protection against unforeseen credit impairments.
Given the lowest required return on shareholders’ equity and
these increasingly tighter rules, this capital adequacy cost has
risen from approximately 3 bp before 2008 to 13 bp at present.
These credit impairments and capital adequacy costs, totalling
approximately 16 bp, must be covered by the bank’s gross
margin on mortgages.
Lastly, we expect our expenses to manage a mortgage
portfolio of well over SEK 700bn “from start to finish” at
approximately SEK 2.2bn (including a portion of the Treasury
department’s costs to manage funding operations). This
corresponds to approximately 30 bp or approximatetely 20 per
cent of the total expenses of the Swedish retail operations.
These expenses must also be covered by the bank’s gross
margin on mortgages.
Our calculations show that the gross margin on a normal
mortgage – calculated as the difference between the bank’s
actual funding cost and the lending rate charged to the customer
– must be at least 0.65 per cent to cover the bank’s costs for
the mortgage operations and at least 0.75 per cent to also cover
our shareholders’ return on the bank’s equity. As a product,
mortgages have not been profitable for Swedish banks for long
periods of time. This is because the net margin has been negative
after factoring in expenses for liquidity, credit impairments,
administration and costs related to our shareholders’ required
return. Mortgages have instead been used as a door opener to
other types of business with the customer.
Gross mortgage margin (3 months)
%
6
5
Net margin
4
3
2
1
0
2003
2004
Gross margin
Swedbank's funding cost
2005
2006
2007
2008
2009
2010
2011
The gross margin
covers:
• Cost of liquidity
≈ 0.2%
• Administrative costs
≈ 0.3%
• Cost of capital
≈ 0.13%
• Credit impairments
≈ 0.03%
3-month STIBOR
Riksbank's repo rate
The banks can no longer obtain funding at the repo rate level. Since the financial crisis culminated in autumn 2008, funding costs have increased
in relation to the repo rate and STIBOR. Increased expenses due to new and tighter regulations have led to higher gross margins. Furthermore,
the gross margin must also cover costs for administration and credit impairments.
Swedbank Annual Report 2011