Bank economist and analysts are again worrying about net interest margins in the wake of first quarter economic data that virtually assure fresh hikes in interest rates by the Federal Reserve Board,
"For bank margins, it has become a question of defense and not offense," said Sung Won Sohn, senior economist at Norwest Corp., Minneapolis.
Last week the federal government estimated that the nation's ecomony, as measured by the gross domestic product, grew 2.6% in the first quarter, down significantly from the booming 7% rate of the fourth quarter,
But bank economists, recalling the harsh winter, saw the first quarter as strong. "We estimate the weather substracted as much as two percentage points from the GDP data," the economist said.
A 4.6% annual growth rate "is still pretty strong and certainly higher than the long-term trend rate of 2.7%."
The margin -- that is, a bank's net interest income divided by its earning assets -- has been a fixation for bank stock investors during the past year as they have evaluated the industry's earnings prospects.
The focus seemed to shift to loan growth as the banks reported their first quarter earnings earlier this month. But everyone assumes the Fed will raise interest rates to stave off inflation it it sees the economy heating up. So the fresh economic data and simultaneous bout of weakness in the bond market have prompted new attention to the idea that bank interest income could soon come under increased pressure.
Margins are already shrinking by most accounts. Analyst Francis X. Suozzo of [unkeyable].G. Warburg & Co. said first quarter margins the at banks he tracks slipped to 3.94% from 4.05% in the fourth quarter and 4.18% a year ago.
Bank analysts at Sanford C. Bernstein & Co. noted a 5-basis-point decline in average margin for the quarter to and 25-basis-point decline from year-ago levels.
Anthony Davis, of Dean Witter Reynolds Inc. saw a slight margin increase - from 4.60% to 4.62% in the fourth quarter - in the average net interest margin among the regional banks he follows.
Mr. Suozzo argued that the 50-basis-point increase in many banks' prime rates after the Fed's most recent rate hike, on April 18, as well as higher reinvestment rates for banks' maturing securities, "should help stabilize margins" in the second quarter.
Mr. Sohn believes that from here on for banks "the name of the game will be in keeping margins from being squeezed further."
He thinks the spread between the banks' prime lending rate and the federal fund rate --. a key factor in banks' margins that is now at 300 basis points -- will be nearer to 250 basis points by yearend and fluctuate no higher than 275 basis points.
That implies a 7% to 7.25% prime rate, since Mr. Sohn think the Fed's target for the funds rate is around 4.5% by yearend. The prime rate now is at 6.75%, while the funds rate is at 3.75%.
Most economists think 4.5% to 5% is the rate level the Fed means when it says it is striving toward a "neutral" monetary policy that is neither too stimulatie nor punitive.
Credit Tightening Expected
"We still have three or four rounds of credit tightening ahead of us," said Mr. Sohn,
"We can look forward to further tightening," agreed Robert G. Dederick, senior economist at Northern Trust Corp., Chicago. "But not a succession of volleys of the sort we have been getting over the last several months.
"A more measures approach, if not in order now, soon will be in order, if for no other reason than that we are going to be starting from a higher base," he said.
The 300-basis-point spread betwene the prime rate and funds rate became the standard during the recent lengthly period when the prime rate was at 6% and the funds rate at 3%.
A Boon to Earnings
The wide spread has been a boon to bank earnings. But Mr. Sohn isn't the only one who thinks it may be harder to maintain it from here.
"We are on the other side of the mountain now," said Wayne Ayers, chief economist for Bank of Boston Corp., referring to the rising rate environment.
Since Feb. 4, when it raised short-term rates for the first time in five years, the central bank has tightened credit three times. It is likely to do so again on May 17, when its Federal Open Market Committee meets next.
So far, the Fed has confined its tightening actions to pushing up the funds rate, which is the rate for overnight borrowings of reserves among banks.
But even a 250-basis-point gap between the prime rate and funds rate should leave banks far better off than in the 1970s, when the prime-to-funds spread was more like 125 basis points, Mr. Sohn noted.
"Back then, every time the banks raised the prime rates, the politicians squawked," he said. "Those days seem to be gone. We are basically letting the market do the job of setting rates now," he said.
The issue is been seen slightly differntly by Mickey D. Levy, chief financial economist at NationsBank Corp., Charlotte, N.C.
Costs of Spread
"Can banks maintain that 300-basis-point spread? The anser is yes," he said. "But they had better recognize the cost involved in doing so."
The cost has been a declining market share of assets and deposits for the industry, he said.
The banks have become a relatively expensive source of funding in contrast to the commercial paper and other markets, he said.
Loan growth could help boost margins, he said, but it is unclear how strong loan growth will be.
"Loans have increased modestly over the past few months, and they should continue to do so. But businesses have been generating good growth in corporate profits, and this is kicking off a lot of internal cash flow," Mr. Levy pointed out.
"This," he said, "has allowed a fair amount of economic expansion to go on without very much loan demand."