Question

1. A savings institution (SI) has funded $12 million of 30-year fixed-rate mortgages with an average interest rate of 5.75 percent. These assets are funded with time deposits with an average maturity of six months. The deposits are currently paying 3.5 percent. In six months time, however, the Fed has raised interest rates twice and the depositors now must be paid 4.25 percent. What will happen to the SI's ROA and NIM? How would your answer change if the SI normally sells the mortgages every six months and originates additional new mortgage loans?

Answer 1

Return on Asset:

Return on asset shows the ability of the company to generate revenue on the asset of the company. A higher ratio is an indication that the company is able to use the asset of the company efficiently to generate revenue.

Answer and Explanation:

Given values:

Amount funded = $12,000,000

Interest rate = 5.75%

Maturity = 6 months

Fixed-rate mortgages = 30 years

Current deposits = 3.5%

Depositors paid = 4.25%

Computing:

Original gross profit margin = Interest rate - Current deposits

Original gross profit margin = 5.75% - 3.5%

Original gross profit margin = 2.25%

After a period of six months:

Profit margin falls = Interest rate - Depositors paid

Profit margin falls = 5.75% - 4.25%

Profit margin falls = 1.50%

Keeping other things constant, this will reduce the saving institutions' ROA and NIM.

If the saving institutions sell the mortgage every six months. The new mortgage rates may be high enough to offset the rising rate of interest on the deposit.

Hence, preserving the profit margin and ROA and ROE.