Bank Loan Spreads Hold Up Despite Low Rates: Interactive Graphic

Amid all the frustration over low interest rates, it might be surprising that bank loans now yield a substantially fatter spread above funding costs than when the Federal Reserve started loosening policy in late 2007.

In fact, the gap between banks’ cost of funds and yields across loan types — commercial and industrial loans, single-family home loans, consumer loans — expanded through much of the Fed’s campaign to stimulate the economy. (See the following graphic. Interactive controls are described in the caption. Text continues below.)

Net interest margins — or the yield on all earning assets less the cost of funding them — have compressed under the weight of large amounts of cash and low-yielding securities, which account for bigger portions of bank balance sheets during the current economic malaise than they did before the recession.

Across the industry, the median amount by which total loan yields exceeded funding costs increased from a recent low of 4.32% in the first quarter of 2009 to a recent high of 5.08% in the third quarter of 2011, however. The margin was 4.82% in the first quarter of this year — still a healthy level by historical standards.

The trajectory is similar across loan categories. The spread on C&I loans increased 72 basis points from the first quarter of 2009 to 4.98% in the first quarter this year. The spread for single-family mortgages is up 32 basis points to 4.72% over the same time.

In general, spreads on loans fell from 2003 through 2008. For most of that period, bank loan growth was strong and the Fed was trying to drain the punch bowl by tightening rates.

Aggregate spreads — those constructed by adding up interest income and loan volume across banks — show a similar pattern. The industrywide aggregate is heavily influenced by giant banks, while medians tend to track with the thousands of small institutions that make up most of the bank population.

(The interest income that underlies yields includes loan fees, but of course does not take into account the additional earnings that some loan relationships create when borrowers do other business with their lenders. Medians used here are based on data for about 7,000 banks that were in operation as of the middle of this month.)

Yields provide only an incomplete picture of the lending environment. Regulators are worried about bankers selling “out-of-the-money puts” in the form of weak underwriting standards. That is, bankers may be willing to lend without sufficient protections, exposing themselves to risks that do not appear on the financials they report to the public until the options come into the money, if they ever do, because of a downturn in the economy and a wave of defaults.

Now that long-term interest rates have jumped, attention has turned to the tangle of offsetting channels by which bank earnings could be affected. Mortgage production revenues are likely to be clobbered, the value of long bonds has taken a beating, asset-sensitive banks might not see much of a lift to the extent that they are leveraged to the intermediate part of the yield curve, which has not moved as much.

For the squeeze on net interest margins over the last year or two, however, securities and cash may have played a more direct role than loan spreads.