GoSeigen wrote:Sorry, not 100% clear there. Yes I'm talking about the principal part of the repayments which is growing as a proportion of total payment because the loan size is decreasing. I'm guessing there will be two effects: first, continued subdued lending compared to when these mortgages were issued (in the noughties boom) which will positively affect cashflows into the business and secondly, the reduction of outstanding loans on the BS which will free up capital and result in cashflows to shareholders, IMO.
No worries, I see what you mean, I think. And agree that lending (esp. remortgaging) must have subsided since the 00s. I had a little think about how a mortgage firms (i.e. bank) balance sheet could possibly look. Presumably mortgages held by their customers are on the bank's asset side, with their present value (PV) being equal to the sum of all the DCF of the future payments. I'm then assuming that each payment (made by cust to bank) is an inflow ("Cash from operations").
Sorry, don't know the detail of the accounting, but the general description of the asset is correct.
But further the bank does not have a forest of money trees, so I'm guessing that bank themselves presumably borrowed money from lenders of some form e.g. bond-holders, money market etc.. And these borrowings are on the liabilities side of the BS.
I recall discussing this subject with you some time ago in connection with QE/money!
Sorry to say, it is still my view that the liability side of the transaction IS a money entry, usually a demand deposit. To put it in everyday language: bank agrees a loan with customer which means that customer promises to pay back the bank (the mortgage), whilst the bank agrees to credit customer's current account with cash (money).
So there is
a money tree but but no-one called it that until they wanted to insult the labour party, or Keynesians!
Therefore it should be clear there is no money borrowed from lenders of any form to fund the mortgage. It really is just created. What DOES happen is that banks raise (and are required to raise) a small amount of capital in the form of bonds, hybrid capital, shares etc in addition
to their monetary (deposit) liabilities which is a buffer against losses in their business and they purchase high quality assets alongside the mortgages to ensure adequate liquidity.
So going back to when you said principal part of the repayments which is growing as a proportion of total payment because the loan size is decreasing I'm not 100% sure that that's relevant regards the customers paying back their mortgage, and the ingress flow reducing the bank's asset and feeding the bank cash. What I believe is more relevant in terms of the banks cash generative properties is how their own repayments are structured regarding how much of current's periods inflows are needed to pay down just interest on their outstanding bonds, or the principal when the debt matures. But I guess with a firm like lloyds these must be fairly staggered into lots of different borrowings with varying maturities.
No really, most of the liabilities are customer deposit balances (money). Banks pay a lower rate on these than they demand from mortgagees. That is the main driver of NIM. When principal is repaid, both the loan asset AND the deposit liability decrease. This in and of itself does not generate cashflow as I accepted earlier BUT because the balance sheet is smaller the bank is required to hold less regulatory capital and/or the risk of its business decreases giving them access to cheaper reg capital. So these indirectly contribute to improved profitability.
Crude example of a bank balance sheet:
Mortgages 900 [interest rate 3%]
Deposits 800 [interest rate 1%]
Sub debt 100 [interest rate 6%, say]
If net 100m of mortgage principal is repaid then the balance sheet is:
Sub debt 100
but the bank now has a larger proportion of capital than before. It can redeem some sub debt, reducing the 6% interest payments. Or it can swap the sub debt for 5% notes because it is safer than before, again saving some interest. Or it can buy back some of its shares (as LBG is doing), thus returning cash to shareholders.
Low interest rates are a problem, but as many have remarked before, and finally I am starting to agree, they cannot really fall much further and may even go up, especially if we have a hard/no-deal Brexit.
You say that but in Germany the 10 year DE bond has -ve yield (-0.341%), so presumably they have v. v. low base rate. Also surely if the UK has a bad time post brexit, won't the BoE probably cut rates as a stimulant?
Well I'm talking in broad terms here. Of course we could end up like Japan/Germany/Swiz but over the long term I think we must be near the lows of interest rates. If we Brexit without a deal I'd guess interest rates will be hiked magnificently to defend against capital outflows. Yes, devastating for the economy, but we all knew that, right? Any stimulus rate cut would be knee-jerk, short-lived, and a mistake needing to be rapidly reversed IMO.