Low interest rates pressuring US bank margins - Deutsche Bank ...

Low interest rates pressuring US bank margins
The current banking environment is not conforming to history, however. The
initial benefit of low rates has waned without the concurrent growth in lending.
Although funding costs continue to decline, they may not be enough to offset
lower asset yields and they are approaching a limit of zero (see chart 1). With
the Fed announcing no intention to raise rates until the end of 2014, this limit
could quickly constrain bank profitability. Although there are indicators of a pickup
in lending across recent quarters, it may not be enough to make up for the
compression in net interest income. Furthermore, alternative revenue drivers
like non-interest income so far have not provided much support.
Funding costs on a downward trend, nearing zero bound 1
%
12
10
8
6
4
2
0
84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Sources: St. Louis Fed, FDIC
Asset yields Funding costs of earning assets Fed funds rate
Net interest margins (defined as net interest income over average earning
assets) were 3.6% at year-end 2011, just 11% higher from the 20-year low of
3.2% in the last quarter of 2006 (see chart 2). After the initial benefit from low
rates, net interest margins are likely to continue to trend downwards as funding
costs bottom out and asset yields continue to fall. The chart below demonstrates
that net interest margins spiked not only after the most recent crisis but also
during previous recessionary rate environments, as evidenced during the US
recession in the early 1990s and again in 2001-02. In the second half of the
1980s, the decline in inflation and the reduction in the Fed funds rate led to a
corresponding surge in net interest margins.
More precisely, it may be the shape of the yield curve (which is heavily
influenced by the official interest rate) that largely determines the interest
margin. The spread between 10- and 2-year Treasuries demonstrates that as
the yield curve flattens or becomes inverted (indicated in chart 2 by near-zero or
negative values), net interest margins tend to fall. For example, at the recent net
interest margin low in late-2006, the yield curve was inverted. By contrast, as
spreads widen, net interest margins follow suit. The yield curve is likely to
continue its flattening trend as long-term rates draw closer to short-term rates.
The Fed’s recent “Operation Twist” is explicitly targeting lower long-term rates,
with the intention of boosting credit volume in products that track longer-term
Treasury yields such as mortgages and corporate bonds. As a result, further
compressions in net interest margins are likely in the near term.
2 | May 11, 2012 Research Briefing