||Low Rates Pummel Banks
Superlow U.S. interest rates are squeezing bank profits, complicating the industry's nascent recovery from the financial crisis.
An important gauge of lending profitability, known as net interest margin, has dropped to its lowest level in three years. The measure tracks how much banks earn when they borrow from depositors and then lend or invest those funds.
The squeeze is the flip side of the Federal Reserve Board's four-year effort to revive the sluggish U.S. economy, with near-zero short-term interest rates and repeated rounds of bond purchases that aim to reduce long-term rates as well. Ten-year U.S. Treasury yields hit 1.43% in July, their lowest level since World War II.
Banks will be forced to consider new ways to make money by changing the services they offer, industry observers said. At the same time, higher costs for banking services could push more Americans out of the financial system altogether, adding to the millions of customers viewed by regulators as under-banked, or lacking access to affordable financial services.
"The prolonged low-interest rate environment is transforming the banking industry from savings and loans to service and loans," said Dan Geller, executive vice president of research firm Market Rates Insight in San Anselmo, Calif.
Fed officials say their low-rate policy boosts economic growth and employment, which have been slack since the financial crisis, by making it cheaper for companies and individuals to borrow. The superlow rates are encouraging a surge in mortgage refinancing that is bolstering fee revenue at J.P. Morgan Chase & Co. and Wells Fargo & Co., which together control roughly 44% of the mortgage market.
Katherine Karl, a 50-year-old attorney in Brighton, N.Y., was able to close on a home refinancing last week with M&T Bank Corp. that lowered her rate by 2.5 percentage points, to 2.875%. "Interest rates are at a historic low and that is certainly what motivated me," she said. "I'm very happy."
But the Fed's move is turning out to be as much bane as blessing for banks, whose dependence on lending income has grown following a regulatory overhaul and public backlash against fees.
"The longer the Fed stays down at these levels the more it will hurt banks," said Scott Lied, the chief financial officer of ENB Financial Corp., an Ephrata, Pa., institution that has eight branches and 225 employees. "It's painful."
Over time, subdued bank profits are likely to accelerate a shakeout that has halved the number of insured institutions over the past two decades, by increasing the pressure on smaller banks to bulk up to take advantage of new technologies and of loosened restrictions on interstate branches.
Hudson City Bancorp, a Paramus, N.J., lender whose profits have been hammered by falling income on its large mortgage portfolio and which agreed in August to sell itself, said in a recent filing that the Fed's moves "had an adverse effect" on the company, which has $43.6 billion in assets.
The spread between banks' deposit and lending rates has narrowed in part because of low Fed-influenced rates and slack demand for loans amid soft economic growth. Net interest margin fell during the third quarter at 79% of all banks tracked by investment bank Keefe, Bruyette & Woods. The average margin for the industry's largest banks, at 3.12%, is the lowest since the second quarter of 2009 and has been dropping since the third quarter of 2011, according to data tracker SNL Financial.
As higher-yielding loans and securities acquired before the crisis mature, the banks are forced to replace them with assets that carry much lower rates. With some sources of lucrative fee income such as debit card charges capped in 2010's Dodd-Frank law, the margin squeeze has an outsize impact on the bottom line.
Banking-industry net interest income last year was $422.58 billion, or 65% of revenue, according to Federal Deposit Insurance Corp. data. That is up from $397.68 billion, or 60%, in 2009. The declining net interest margins over the past few years suggest that a recent recovery for the industry's bottom line could be fleeting. U.S. banks earned $114.39 billion last year, their best showing since 2006.
"Growing earnings will become more difficult over time unless interest rates move up," said Fred Cannon of Keefe, Bruyette & Woods.
BB&T Corp., a regional bank based in Winston-Salem, N.C., watched its stock drop more than 7% recently when its net interest margin dipped to 3.94% in the third quarter from 4.09% a year earlier. The chief financial officer of the nation's 11th-largest bank by assets said the figure will likely decline in the fourth quarter to roughly 3.75%. When BB&T convened a conference call to discuss the results, half of the 14 questions asked by analysts were about the bank's slumping margin.
"Artificially low rates are not good for anybody," said Daryl Bible, BB&T's chief financial officer. "Rates are way too low for this stage in the recovery."
The lower returns also are reducing banks' benefit of holding depositors' cash at rock-bottom rates. Domestic deposits at federally insured banks and thrifts rose 8.4% to $8.91 trillion at June 30, the latest available FDIC data show, from $8.23 trillion a year earlier. The problem for many banks is that surging deposits have left them with more money to invest at a time when returns on securities are poor and the cost of funding can't be lowered much further.
Deposit rates are already at their lowest levels since the 1950s; the five-year certificate of deposit dropped below 1% for the first time in mid August and is now 0.93%, according to Market Rates Insight.
An inflow of deposits during September was a big reason for a 0.25 percentage-point decline in Wells Fargo's net interest margin for the third quarter, to 3.66%. Its average deposit cost during the quarter was just 0.18%, compared with 0.19% the prior quarter.
"Banks may have to say 'we don't want these deposits,'" said Gerard Cassidy, banking analyst with RBC Capital Markets. "That is sacrilegious for banks to think that, let alone do that."
In its search for more yield, Wells Fargo said it kept nearly $10 billion of residential mortgages it would normally sell to investors. Other banks question that strategy, saying that doing so exposes them to losses if rates were to rise suddenly. That is because bond prices and interest rates move in opposite directions. Rising rates can leave holders of bonds issued at low yields holding debt they can't sell into the market without taking a loss.
Some bankers that bet on higher-yielding mortgage bonds already have paid the price. Hudson City decided to sell the bank to M&T Bank largely because it placed too many mortgage loans on its books before rates fell.
When Hudson City customers refinanced, yields on the bank's mortgage portfolio tumbled, slashing income and leaving investors skittish about the company's future as a stand-alone entity. "These market conditions have made it very difficult," the bank said in an Oct. 12 regulatory filing made jointly with merger partner M&T.
Some banks are reacting to the low rates by getting more aggressive on loan pricing, hoping to offset the margin squeeze by increasing lending volume. J.P. Morgan Chairman and Chief Executive James Dimon this month acknowledged such an approach on certain home and auto loans. Other lenders are loosening terms on commercial and industrial loans for small and midsize businesses.
"It's a fistfight out there in terms of competitive pricing day to day," Lars Anderson, a vice chairman of the Business Bank at Dallas-based Comerica Inc., told analysts on an Oct. 17 call.
But Mr. Lied of ENB Financial said he can't afford to load up on new loans because he knows he will "take it on the chin" if rates rise. Net interest margin for the bank, which has $784.8 million in assets, dropped by 0.09 percentage point in the third quarter, after a 0.06-point decline in the second quarter.
Many smaller banks will "throw in the towel" and sell, as Hudson City did, if low rates persist, Mr. Lied said. "There are no magic bullets and there is no easy answer."
(Source: The Wall Street Journal, 10/23/12)
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