The country’s biggest banks have witnessed a marked decline in their net interest incomes for several consecutive quarters now, in what is a direct result of the prolonged low interest rate environment maintained by the Fed since the economic downturn of 2008. While the net interest margin (NIM) figures for banks are still under pressure, the Fed’s decision to begin tapering its bond purchase program later this year may finally ease this pressure early next year. After all interest rates already started showing perturbations towards the end of Q2 2013.
But until that time, the country’s biggest banks have no choice but to grin and bear with the shrinking interest margins. This has been a bigger source of concern for banking giants Wells Fargo (NYSE:WFC) and U.S. Bancorp (NYSE:USB), which rely on the traditional loans-deposits model for a majority of their income. While shrinking interest margins is no doubt a problem for the three biggest U.S. banking groups JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C) too, their substantially diversified models mitigate the risk from lower interest incomes on their bottom lines to a large extent.
In this article which is a part of our continuing 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.
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The Federal Reserve set interest rates at 0% to 0.25% in December 2008, and has maintained them at that level since. The rationale behind low federal fund rates is simple. When these 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 coax individuals and companies looking for money to borrow, allowing the economy to slowly grow back 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) diligently purchasing $85 billion worth of debt and mortgage-backed securities from the market each month.
Over the recent months, there has been a change in the Fed’s stand though. 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 beginning later this year (see The Fed’s Plans To Taper Asset Purchases: Good Or Bad News?). As this would mean a gradual reduction in liquidity, it would result in a rise in interest rates.
But while this is the expected future of interest rates in the country as of now, the past demonstrated a very clear trend – shrinking net interest margins. The table below shows the NIM figures for the five largest banks for each of the last ten quarters. The figures were reported by the banks in their respective quarterly SEC filings.
|Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013|
|Bank of America||2.66%||2.49%||2.31%||2.44%||2.50%||2.20%||2.31%||2.34%||2.43%||2.43%|
As is evident from the table, NIM figures for all the banks have fallen over the period Q1 2011 to Q2 2013.
The largest decline was witnessed by JPMorgan with NIM figures falling 69 basis points (0.69%) over the period – a considerable decline – followed by Wells Fargo whose NIM figures sequentially fell 59 basis points (0.59%). Quite interestingly, it is these two banks that have the highest and lowest NIM figures among the banks listed here.
So why the discrepancy, you ask. There are two factors responsible for the difference between NIM figures for the banks at the top of the list (Wells Fargo and U.S. Bancorp) and those at the bottom of it (JPMorgan and Bank of America): business model and capital structure. The business model directly affects the NIM figure as some types of loans and securities inherently draw more interest rates than others. No doubt the focus Wells Fargo and U.S. Bancorp have on the mortgage industry acts as a plus in this regard. Wells Fargo in particular earns a lot of interest income from its portfolio of mortgage-backed securities.
As for the impact of the capital structure on NIM figures, it is obvious that the more long-term debt a bank has on its balance sheet, the more it will pay as interest expenses; reducing its NIM figure in the process. JPMorgan has more than double the size of long-term debt compared to Wells Fargo ($270 billion for JPMorgan vs. $125 billion for Wells Fargo), and the debt burden clearly weighs against the former in the big way.
You can get a better understanding of the partial impact of changing net interest margins on the bank’s total value by making changes to the chart below, which represents Wells Fargo’s NIM on outstanding mortgages.