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Updated on Friday, January 16, 2015
The US banking scene is dominated by four mega-banks: Bank of America, Citibank, Chase and Wells Fargo. On January 14th and 15th, these banks reported their earnings. At MagnifyMoney, we look closely at the results of the credit card and retail banking divisions to see what they can tell us about the state of the American consumer, the cost of credit and the trends in savings account rates.
The headlines talked about disappointing earnings, and compressing net interest margins due to a low rate environment. But the mega-banks include consumer banking, as well as corporate and investment banking. If you peel the onion and look at the consumer business, you will see that banks are maintaining (or even expanding) their spreads in the consumer business to counter-act declining margins elsewhere. Although there have been massive settlements and penalties, banks are using low interest rates on savings accounts and high interest rates on credit cards to cover the costs of those settlements. So, while middle class America may feel good about seeing the headline settlement costs, they are in fact funding those settlements through their banking relationships.
Here is a quick summary of what we found
- Banks continue to make outsized returns in their consumer banking and lending franchises: The Return on Equity of the consumer businesses remains high. Chase generated a 31% ROE. Bank of America generated a return of 26% (with a 36% return from the consumer lending business). Most banks have a target return of 10% – 12%, and their investment banks tend to be below the target return.
In the credit card industry:
- Consumer spending is increasing: People made more purchases on credit in the last 3 months of 2014 than they did during the same time in 2013. Depending upon the bank, spend increased from 3% to 10%.
- And people are paying their bills: The percent of people who are 30 days (or more) late on their credit card bills continue to decrease across all of the major issuers. Delinquency ratios were down 10% – 18%.
- Credit card businesses continue to generate impressive yields: Borrowing on credit cards is expensive, and (despite all-time-low interest rates) banks continue to defend margins. The largest lender, Chase, saw its yield increase from 9.1% to 9.2%. Note: That number looks a lot lower than the interest rate paid by credit card borrowers, because people who pay their balance in full pay no interest. In addition, banks have promotional offers (for example, 0% interest rates), which bring down the blended yield. Our review of credit card interest rates show that, for borrowers, they can expect to pay 15% or higher if they do not have a promotional rate.
Credit card companies make money in the following ways:
- Interchange on spending: Every time you make a purchase on a credit card, the bank typically receives about 2%. Spending is increasing, so interchange revenue should be increasing.
- Interest charged on borrowing: As people spend more, you can expect that they will revolve more. And, given that interest rates are being held firm despite low rates, this is an area of strength for banks.
- The main costs for a credit card business are:
- Operating expenses: the cost of people, equipment, marketing, and other similar expenses.
- Credit costs: when people do not pay back, the balance is written off at 180 days past due.
- Funding costs: banks just borrow the money from someone else in order to lend to consumers.
- Credit and funding costs are still at cyclical lows.
All of the key drivers of credit card profitability remain strong. Don’t let the building and release of reserves confuses the situation. Because credit card businesses are growing, they will have to build reserves. But that does not mean that the business is doing worse – it is just a tax for growth. The underlying businesses have been strong, and delinquency remains low. However, future growth will come from expanding into higher risk segments. Expect to see more credit available in the next 12 months – especially to people who are higher risk. You can also expect to see delinquency start to deteriorate over an 18-24 months time frame, as these newer booking vintages begin to season.
Interest on deposits remains shockingly low
If you are looking to save money, the biggest banks are the worst place to keep your money. There is a war being waged online for deposits, with the best rates now reaching 1.25% for large balances. However, the interest rates paid on deposits at large banks remains shockingly low.
- If you wanted to open a savings account today, Citi, Chase, Wells Fargo and Bank of America all pay 01% on a traditional savings account.
- Wells Fargo bragged that the average cost of deposits declined to 0.09%, which is 2 bps lower than a year ago. And total deposits were up 8% Year-over-Year.
- Bank of America bragged that the “rate paid on deposits declined to 0.05% in Q4 2014.”
What does this all mean?
- Banks continue to get away with overcharging and underpaying retail banking consumers (a.k.a the middle class). The returns in the consumer business remain incredibly high.
- If you are looking to borrow, don’t expect the near-0% interest rates to be reflected in your credit card interest rate. Banks continue to defend their top line interest rates, and credit cards for the mega-banks remain incredibly expensive ways to borrow.
- If you are looking to save, the mega-banks have ignored the price war that is happening online. Yet, for some reason, we continue to give them money. Interest rates continue to decline, and banks continue to brag about it.
There is one upside to all of this: banks want more credit card debt. So, you can expect more aggressive 0% offers to lure customers. For savvy debt surfers, this means you will have more option to cut the cost of your interest and reduce the time that it takes to pay back your debt. We have just seen that in early January with Citizens Bank launching a 0% balance transfer offer for 15 months, with no fee.
Otherwise, the financial results just reaffirm our belief: your basic banking and borrowing should not be with the giant mega-banks.