Margin pressure could dog banks into 2022

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The coronavirus pandemic has so devastated the economy that there has been little time for hand-wringing in the banking industry over near-zero interest rates.

But with rates so low — after steep emergency Federal Reserve cuts in response to the pandemic’s fallout — banks will struggle to generate bread-and-butter interest income and asset-sensitive lenders will face substantial net interest margin contraction this year and next, analysts say.

“All the stars are lining up negatively right now for the banks,” said Ron Shevlin, director of research at Cornerstone Advisors.

Piper Sandler analysts estimated that, across their coverage universe of 200 banks, the median net interest margin will shrink 18 basis points in 2020, falling below the century’s 2009 trough reached in the wake of the financial crisis, and then shrink another 11 basis points next year to 3.30%.

“We hope NIMs can begin to bottom as we get into next year,” the Piper Sandler analysts wrote in a report.

Net interest margin projection

They project that interest income will grow by about 3% this year, driven by large draws on commercial lending lines made by business owners to bolster liquidity as the pandemic took hold late in March and in April. But that growth would still be half of what banks generated last year, and the Piper Sandler analysts look for interest income to be flat in 2021.

Most community banks — and many regionals — earn more than half of their income on interest. With the sudden and severe drop in rates this year, floating-rate loans quickly reset lower and new fixed-rate loans will come on the books with rates lower than older loans getting paid off.

Deposit rates come down, too, but based on history, analysts broadly expect the interest banks pay depositors to come down gradually — over several quarters. The result: The margin between what banks pay for deposits and earn on loans gets squeezed.

Banks started to feel the pinch in the first quarter. Comerica in Dallas is a case in point. The $76.3 billion-asset regional banking company said its net interest income declined by $31 million from the prior quarter to $513 million, and its margin fell by 14 basis points to 3.06%.

“The major factor was lower interest rates,” President and CEO Curtis Farmer said on Comerica’s recent earnings call.

Farmer said deposit costs declined in the quarter, but only enough to offset about half of the negative impact of lower interest income on loans. He hopes continued commercial line draws and fee income from ongoing Small Business Administration Paycheck Protection Program loans will help offset margin challenges in the near term.

Keefe, Bruyette & Woods analyst Christopher McGratty said income earned on PPP loans could cushion the impact of low rates this quarter and into the next. Still, “the low-rate environment will continue to provide a revenue headwind” for most banks, he said.

Additionally, PPP loans that are not forgiven by the federal government would add pressure on margins because they carry 1% interest rates. Shevlin said most banks would lose money on loans priced at that level.

Brookline Bancorp in Boston endured a significant blow to its net interest margin in the first quarter and, with no clear vision on the duration of the pandemic-induced recession or when the Fed will lift rates from basement levels, the company’s chief financial officer said it did not make sense to provide an outlook.

“There's a lot of variability, and I'm not really comfortable trying to give you an estimate on what the margin is going to be,” CFO Curt Carlson told analysts during Brookline’s recent earnings call.

The $8.5 billion-asset company said net interest income decreased by $2.2 million to $61.7 million during the first quarter, as loan yields declined, and its margin compressed by 12 basis points to 3.31%.

While the economic outlook is muddied, one aspect of the operating environment for banks that is clear is that rates are expected to remain ultralow indefinitely, economists say. The Fed has a mandate to combat unemployment, and keeping rates low to make credit affordable is one of its principal tools.

“If it ends up being a longer, harder path back to lower unemployment, then I think that we’re going to have more damaged skills and workers,” Chicago Federal Reserve President Charles Evans told reporters by teleconference on May 5. “That would be an environment where interest rates would be lower for longer.”

The jobless rate soared to a record 14.7% in April, and it is widely projected to worsen in May.

Raymond James Chief Economist Scott Brown said the true April jobless figure is closer to 20% after accounting for furloughed workers. “It’s a pretty gigantic amount of job loss,” he said. “We don’t think it’s over.”

Brown said the annualized hit to U.S. gross domestic product in the second quarter could reach 30%. If states are successful in opening up their economies over the summer months, GDP could start to stabilize in the third quarter. But Brown said he does not expect a return to meaningful growth this year.

“It’s going to be a very long recovery,” he said, and rates likely will remain low throughout.

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Interest rate risk Net interest margin Coronavirus Federal Reserve Commercial lending Consumer lending Non-interest income