Net interest margin is a wallflower no longer.
For some time now, the difference between what banks pay to borrow and charge to lend has been less important than noninterest income. But the bad economy and new regulations are squeezing the fees that made companies less dependent on the rate environment, leaving net interest margin to re-emerge as a more important earnings driver.
A survey of company data shows margins at many major banking companies fell markedly in the third quarter compared with a year earlier. There was a trend of gradual improvement from the second quarter to the third, thanks mainly to falling deposit costs and helped along by stronger loan pricing. Some, like PNC Financial Services Group Inc., brought margins back above where they were a year ago, aided in some cases by purchase-accounting perks tied to big acquisitions.
But many companies will face a variety of obstacles along the way, from the impact of maturing swaps bought as a hedge against rate changes to the continuing buildup in bad loans, which removes previously high-yielding assets from the mix.
"Nonperforming loans pay no interest, but they still could be on the books, so you put a big, fat zero next to those, and that's going to drive the margin down," said Rick Weiss, an analyst with Janney Montgomery Scott in Philadelphia. "That would affect banks more in the Southeast and West much more so than the Northeast or mid-Atlantic, because that's where you saw more of the construction and commercial real estate loans that had relatively higher yields."
Nonetheless, even some banks that have taken big hits on construction and real estate loans in tough markets expect net interest margin to continue to expand, as a result of declining deposit costs.
Speaking Tuesday at a Bank of America Merrill Lynch conference, Fifth Third Bancorp Chairman and Chief Executive Kevin T. Kabat indicated that the pressure on net interest margins, which peaked in the first quarter "during a period of very high competitive rates and a volatile environment," has started to ease with higher-yielding certificates of deposit being replaced with lower-cost ones.
At 3.43%, the third-quarter net interest margin at Fifth Third was well below the 4.24% reported a year earlier. But compared with the second quarter, the margin was 17 basis points wider, and Kabat said he expects "another 10 basis points or so of expansion in the fourth quarter as some of our high-cost, legacy CDs continue to roll over."
Regions Financial Corp. also expects to see margin benefits throughout the coming year.
"We do have about $4 billion in CDs maturing this quarter, and we're repricing those at substantially less than they were on the books for," C. Dowd Ritter, Regions' chairman and CEO, said at the same conference.
PNC has had dramatic margin growth with the acquisition of National City Corp., which doubled PNC's size. But the improvements have gone above and beyond the purchase-accounting benefits of the Dec. 31 takeover. PNC, which expects $7 billion of retail and brokered CDs to roll off this quarter, told investors last month that they were repricing deposits at levels below where the National City deposits had been marked at the time of the acquisition.
"We're realizing more than the accretion" from the accounting benefits, Chairman and CEO James E. Rohr said on PNC's third-quarter earnings call.
But as a banking company that has yet to repay funds from the government's Troubled Asset Relief Program, PNC may be somewhat hamstrung in its ability to widen margins.
Companies still holding the funds "are increasing their liquidity in their portfolios in order to position themselves to repay Tarp early, and they are earning very little on it," said Gary Townsend, the CEO of Hill-Townsend Capital.
U.S. Bancorp, which repaid its Tarp money earlier this year, posted a third-quarter net interest margin of 3.67%, up from 3.65% a year earlier, while Citigroup's margin shrank from 3.15% to 2.93%.
U.S. Bancorp Chairman and CEO Richard K. Davis told investors at the Bank of America conference that they can look forward to continued stability in U.S. Bancorp's margin levels.
"It continues to have a slight positive bias in future quarters, but isn't far from where it will be for the near term," Davis said.
Regions, too, expects stability in the margin, which contracted to 2.73% in the third quarter from 3.1% a year earlier, as industry headwinds offset the impact of lower funding costs.
"Despite … low-cost deposit growth and pricing improvements, we think that the drag from nonperformers will continue to hurt the margin as well as the impact of some maturing interest rate swaps," Ritter said. "Bottom line, we expect the margin to remain about where it is in a stable environment near term, but we think it will increase as rates increase."