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What’s Behind Banks’ Variable Rate Changes

variable-profit-marginsWhy did RBC and TD cut their variable rate discounts and spark an industry trend? Here’s the reason straight from the source (Dave McKay, Group Head, RBC Canadian Banking):

“A combination of factors in the price increase on Wednesday; one, there was a dislocation between the price of the fixed rate book versus the variable rate book which was encouraging, I guess, consumers to really move into a much, much lower variable rate book, which had very, very thin margins.

At the same time, we’re seeing a slight volatility in funding costs in the swap market. So, given the dislocation between fixed and variable the very, very thin margins, we felt we needed to move prices up in our variable rate book.

…I think the fixed rate business is well priced and earning a fair return. I think there was an anomaly with the intense competition in the variable rate mortgage business, consumer preference being, I think, artificially driven there because of the price differential to fixed, we had to get it back and to have more even keel. So, I think those were (summative).

Along with the funding volatility that we’re seeing, we needed to make sure that this product earns a fair return for shareholders. So, we moved rates up.”

Profitable-mortgage-spreadsIn other words, fixed-rate mortgages were oozing profit while variable mortgages weren’t paying the bills.

The fact is, if banks priced fixed mortgages commensurate with true funding costs (i.e. reduced fixed rates to match lower bond yields), more people would gravitate to fixed mortgages on their own.

5-year fixed money really should be closer to 3.00% right now (based on the cost of funds). Instead, lenders are exacerbating their variable-rate margin problems by keeping fixed spreads artificially inflated.

The above quote comes from today’s RBC earnings call. Conference call source: Morningstar.

Rob McLister, CMT