Saturday, December 11, 2010

Interest rates, banking profits, and predatory lending

I like to get firsthand experience of things. When I heard that a local bank of mine was missing its TARP payments and possibly close to bankruptcy, I thought about opening an account. I wouldn't mind getting the experience of having my accounts transferred or being paid by the FDIC. Lately I've been lucky: I have an open directors & officers' insurance policy claim (I didn't file the lawsuit) and I recently got a $1,000 payout for a dink in my car (first insurance claim).

About a week ago I went into Wells Fargo to wire some money to China. I had purchased a credit report on a Chinese stock that I was invested in - the credit report used the SAIC (State Administration for Industry and Commerce) financials, which are often different from the financials that these companies file in the United States. The credit report confirmed my suspicions and I closed my investment at a loss. I was helped by a personal banker, and while I was there she suggested that I take out a personal line of credit.

I told her I didn't need it, but I was easy to sell on the idea: I wanted to see what the experience was, and I wanted to see what kind of interest rate they'd offer me. They found I have a credit score of 777 and I disclosed that I make about $45k a year. I have no debt. They offered me $6,600 with an interest rate of 8.750% plus the Prime Rate published in the Wall Street Journal Western Edition. As of November 29, 2010, that meant an interest rate of 12%. However, this was subject to a floor of 14.50% and included a discount of 25 basis points for automatically deducting payments from my checking account. I also went through a process of upgrading my checking account, and in that process I discovered in the documents provided that Wells Fargo actually does payday lending through a program called "Direct Deposit Advance".

I had reminded the banker several times that I was not interested if there were no fees. Reading the contract, I saw an annual fee of $25. I spoke to her about it and she said her manager assured her that it was waived the first year. So I went along with it. When I get the line, I was immediately charged $25, and interest began to be charged soon after ($0.03 was charged as interest). She offered to remove the fee, but I was glad to be rid of the line. I guess that goes to show that you can't trust words. If it had been serious, I would have gotten it in writing first, although I doubt that would have mattered much with the computer's programming.

Although not clearly related to the above story, I've sometimes idly wondered what the net effect the Fed lowering interest rates was on banks. The banks charge less in interest, but they also pay much less in deposits, so the effect on the net interest margin could be OK. As my experience shows, banks can still charge a fairly hefty interest rate to me, a borrower with very good credit. Plus, the lowered interest rates stimulates additional loans. The Dallas Fed's Southwest Economy said in 2003 that the lowered interest rates have, prior to 2003, been closely correlated with higher net interest margins, basically because low short-term interest rates are typically associated with a steep yield curve, and banks (accepting the risks of maturity mismatch) invest the deposits for which they are paying very little interest in longer-term assets. The effect had notably broken down in 2001-2003, and the author says this is because "interest income on many of [bank's] floating-rate loans falls with market rates, but deposit rates on short-term accounts fall by less as overnight rates get closer to zero and account management expenses become relatively more important". I don't exactly follow how this is different from the earlier years, but I guess it has something to do with the trend towards banks getting involved in money market funds.

A propos of the above discussion, Morningstar recently sent out an article on the implications of interest rate hikes (When Interest Rates Rise, Will the Tide Lift All Boats?). They target retail brokers as the greatest beneficiaries,

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