One of the biggest concerns among investors in the banking sector over the last several quarters has been the notable decline in the net interest margin (NIM) figures reported by the country’s biggest banks. The shrinking NIM figures are a result of the low interest rates maintained by the Federal Reserve since the economic downturn of 2008, and this in turn has dragged down the revenues generated by banks.
But with the Fed hinting at plans to taper its economic stimulus package in mid-2013 (and finally confirming the move in December 2013), interest rates began to climb in the second half of the year despite benchmark interest rates remaining unchanged. The positive impact of this development is visible in the reported NIM figures for the country’s three largest banking groups - JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C) – all of which reported a quarter-on-quarter increase in interest margins in Q4 2013, the first such increase in at least three years. Notably, the other two largest U.S. commercial banks - Wells Fargo (NYSE:WFC) and U.S. Bancorp (NYSE:USB) – are still struggling with their interest margins. We attribute this discrepancy to the traditional loans-deposits business model of these two banks, which is likely to take a few quarters to reflect improvements in the overall interest environment.
In this article, which is the first of our series on the relative performance of the country’s five largest commercial banks on several pertinent measures, we detail how these banks’ NIM figures have changed over the recent quarters and what to expect in the coming quarters.
The Federal Reserve set its benchmark interest rates at 0% to 0.25% in December 2008, and has maintained them at that level since. When federal fund rates are kept low, banks can afford to give out loans — be it personal loans, commercial loans or mortgages — at lower interest rates. This should in turn encourage individuals and companies to borrow, allowing the economy to slowly return to health. In order to sweeten the deal and ensure additional liquidity in the economy, the Fed also announced a series of Quantitative Easing (QE) measures, with the current one (QE3) purchasing $85 billion worth of treasury and mortgage-backed securities from the market each month.
Since mid-2013, the Fed has revised its stand, though, with the perceivable improvement in key economic indicators giving them a reason to slowly take their foot off the gas pedal (see The Fed’s Plans To Taper Asset Purchases: Good Or Bad News?). While they intend to keep interest rates at the current low for the foreseeable future, they are looking to slowly do away with the asset purchase program – something they are already in the process of doing.
While this, coupled with the eventual increase in federal fund rates, will result in net interest margin figures at banks moving higher in the long run, the NIM figures are likely to move erratically in the near future – especially for banks which rely more heavily on loans and deposits to make money – as the low benchmark rates will continue to fuel a growth in deposits at a faster rate than loans. At the same time, the reduction in liquidity will help increase interest income. These opposing market forces will take a few quarters to normalize interest margins.
This process of normalization has already begun to show through in the NIM figures at the country’s biggest banks. The table below shows the NIM figures for the five largest banks for Q1 2011 as well as each of the last eight quarters. The figures were reported by the banks in their respective quarterly SEC filings. The weighted average figure is arrived at by weighing each bank’s interest margin for the quarter with the average interest-earning assets it reported for the period.
|Q1 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013||Q3 2013||Q4 2013|
|Bank of America||2.66%||2.50%||2.20%||2.31%||2.34%||2.43%||2.43%||2.43%||2.55%|
As is evident from the table, NIM figures for all the banks fell considerably from Q1 2011 to Q3 2013, before finally increasing for the first time in Q4 2013. It should be noted that the increase is only in the interest margins at the three largest banks. While it can be argued that the NIM figures at these banks were quite low compared to the other two, it must be remembered that the reason for this is the markedly different business model and capital structure for these two groups of banks. These differences can determine how quickly or slowly a bank’s NIM figures respond to the overall interest rate environment prevalent in the country.
This trend is good news for the banking sector, and we expect all commercial banks to report higher interest margins by the end of this year. You can get a better understanding of the partial impact of changing net interest margins on a bank’s total value by making changes to the chart below, which represents U.S. Bancorp’s NIM on outstanding mortgages.