Net interest margins, which have been drifting down since a recent high early last year, likely came under further pressure in the second quarter as the yield curve flattened for much of the period (see charts).

The spread between two-year Treasuries and 10-year Treasuries fell 12 basis points from the first quarter, to an average of 264 basis points in the second quarter.

To the extent that banks borrow short and lend long, the shift in the curve is a bad sign for net interest income.

Margins have been fattened by loose monetary policy that has produced a relatively steep yield curve, and hit an industrywide peak in the first quarter of 2010, when a handful of large credit card issuers onboarded about $300 billion of high-yielding, securitized loans under new accounting rules.

The spike produced by that consolidation set up net interest margins for their subsequent slide — large chunks of the receivables added to balance sheets have been charged off.

Still, in addition to gyrations in the yield curve, other factors have weighed on margins, including lower credit spreads as banks compete for loans and a rotation into lower-yielding securities resulting from weak loan demand.

Just as large banks gained the most during the upswing in margins, they have lost the most ground during the retreat. Net interest margins were actually flat with the fourth quarter at 3.73% in the first quarter for banks with assets of $10 billion to $100 billion, and at 3.78% for banks with assets of less than $10 billion.

Yields on earning assets fell roughly in tandem for the small and midsize groups and for banks with more than $100 billion of assets during the first quarter, but the drop in the cost of funds at big banks lagged the other two groups. The relative performance could reflect small and midsize banks' greater reliance on time deposits, which take longer to react to declines in market rates than transaction and savings accounts.

Still, while the yield curve may have increased pressure on net interest margins in the second quarter, pressure from a paucity of loan demand appears to have eased during the period. Besides, despite the recent decline, net interest margins remain higher than they have been for most of the past decade.


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