Banks last quarter managed to defy analysts' grim forecasts for net interest margins, but industry conditions suggest they won't be able to outrun the predictions much longer.
Yields on securities could go even lower as the Federal Reserve considers options for another round of quantitative easing. Loan yields also are poised to fall, as continued weakness in demand for borrowings means loan pricing likely will remain competitive.
Meanwhile, banks are quickly running out of opportunities to reduce deposit costs and improve their own funding costs — levers that helped the industry ward off the degree of margin trouble that analysts had expected to see broad evidence of in the third quarter.
The four largest banks had difficulty keeping margin pressures at bay last quarter, but on the whole publicly traded banks and thrifts reported a sixth straight quarter-to-quarter increase in net interest margin, according to Sandler O'Neill & Partners.
"We have been somewhat surprised by the number of institutions that have been able to lower the last batches of higher-priced borrowings and certificates of deposit to current market rates," Sandler analyst Avi Barak wrote Friday in a research report summarizing the industry's third-quarter performance. "However, barring any change in interest rates, we believe the trend of improving margins will likely reverse itself in coming quarters, as banks can no longer lower their funding costs."
Indeed, at some banks net interest margins already have started their descent.
Citigroup Inc.'s third-quarter net interest margin narrowed 8 basis points from the second quarter, to 3.07%, and Chief Financial Officer John Gerspach indicated that the downward march isn't over.
"Actually, I think we have at least one more quarter of close to a double-digit [basis point] decline in net interest margin," he told analysts during the company's Oct. 18 conference call to discuss third-quarter results. "We still haven't seen the pricing for loans build."
Rivals JPMorgan Chase & Co. and Bank of America Corp. both reported that net interest margin contracted 5 basis points from the second quarter. The drop at Wells Fargo & Co. was steeper, 13 basis points, but executives said the falloff mainly was tied to the portfolio of impaired credits that the company inherited in its acquisition of Wachovia Corp.
Signals from regional banks were more mixed. Some companies held the line on margin, while some registered declines and others showed healthy increases.
But even the ones that fared better warned that the strong gains would not last.
The repricing of higher-cost deposits helped Fifth Third Bancorp boost net interest margin by 13 basis points in the third quarter, to 3.7%. Though the company expects another $1.5 billion to $2 billion of CDs to run off in the fourth quarter, CFO Daniel Poston predicted on an Oct. 21 conference call that the margin would remain stable "in the 370-basis-point kind of range," indicating the strength of the countervailing pressures on margins.
U.S. Bancorp projected that net interest margin will contract this quarter by at least 5 basis points, after expanding 1 basis point in the third quarter. Unlike last quarter, the company won't have the benefit of replacing higher-cost funding with lower-cost funding to help offset the drag on yields from the low-rate environment and from last year's Credit Card Accountability Responsibility and Disclosure Act, which in some instances requires the company to lower the rates it charges customers on card debt.
U.S. Bancorp CFO Andrew Cecere told analysts on an Oct. 20 conference call that in the third quarter, U.S. Bancorp conducted two debt issuances, "both at the lowest rate ever issued by a bank holding company in the U.S. [for] five-year paper and three-year [paper]. And I will tell you that we don't have a lot more issuance planned for the remainder of the year, and we don't have a lot [of debt] rolling off in 2011," meaning there won't be as many chances to fight margin pressures by improving funding costs.
PNC Financial Services Group Inc. had a dramatic drop in net interest margin, as comparisons with the second quarter were skewed by the effects of purchase-accounting adjustments and loan sales.
CFO Richard Johnson asked analysts on an Oct. 21 conference call to instead consider net interest margin on a credit-adjusted basis, which strips out the effect of loan-loss provisions. On that basis, PNC's margin rose from 2.88% in the second quarter to 3.1% in the third, and should be "reasonably stable" this quarter, Johnson said.
PNC's unadjusted third-quarter margin was 3.96%, down 39 basis points from the second quarter. Johnson said the margin will contract again this quarter, albeit at a much slower pace.
Margin compression is compounding earnings pressures as banks also grapple with shrinking balance sheets and the costs of new regulations.
Paul Miller, an analyst with FBR Capital Markets, wrote in a report this week that the third quarter probably was "the peak" for net interest margins. "Without higher interest rates or resumption of loan portfolio growth," he warned, "there is a risk that the [earnings] benefit from reserve release[s] ends before the transition to organic revenue drivers — net interest margin expansion and loan portfolio growth — occurs."