Bank Stock Profit Engine Will Sputter In the New Year

NEW YORK ( TheStreet) -- Banks are likely to face another year of painful contraction of their net interest margins, before seeing a light at the end of the tunnel in 2014.

The net interest margin is the difference between a bank's average yield on loans and securities investments, and its average cost for deposits and wholesale borrowings.

The Federal Reserve has kept its target federal funds rate in a range of zero to 0.25% since late 2008. Last Wednesday, the Federal Reserve Open Market Committee announced that it anticipated "that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored."

The Fed also said that it would continue to purchase agency mortgage backed securities at a pace of $40 billion a month, and that it would continue buying long-term U.S. Treasury securities "initially" at a pace of $45 billion a month during 2013. This stance will be even more "highly accommodative" than it has been during 2012, because the central bank will stop making concurrent sales of short-term Treasuries.

With the short-term rates being so low for so long, most of the largest banks have already seen the bulk of the savings on the funding side, while their assets continue to reprice to lower rates. Looking at the 24 components of the KBW Bank Index ( I:BKX), 13 of the nation's largest banks saw their net interest margins narrow sequentially during the third quarter, while 18 saw them decline year-over-year. Here's how the "big four" U.S. banks' net interest margins fared through the third-quarter:
  • Bank of America (BAC) saw its net interest widen to 2.27% during the third quarter from 2.15% in the second quarter. The third-quarter net interest margin was down slightly from 2.28% in the third quarter of 2011.
  • For Citigroup (C), the third-quarter net interest margin was 2.84%, widening from 2.76% in the second quarter, and from 2.82% a year earlier, making it the only member of the big four club to see its NIM widen sequentially and year-over-year.
  • JPMorgan Chase (Wells Fargo) saw its net interest margin narrow to 2.40% during the third quarter, from 2.42% the previous quarter, and 2.65% a year earlier.
  • Wells Fargo (WFC) had the largest sequential decline in net interest margin during the third quarter among the big four. The NIM was 3.62%, narrowing from 3.83% in the second quarter, and 3.77% in the third quarter of 2011.

Looking past the big four, there were three regional banks among the components of the KBW Bank Index that saw their net interest margins widen sequentially and year-over-year:
  • KeyCorp's (KEY) third-quarter net interest margin was 3.19%, expanding from 2.99% in the second quarter and 3.04% in the third quarter of 2011.
  • First Niagara Financial Group (FNFG) of Buffalo, N.Y., saw its third-quarter net interest margin expand to 3.51% from 3.18% the previous quarter and 3.41% a year earlier, as the company's funding cost declined from its net acquisition of roughly 100 branches from HSBC (HBC).
  • M&T Bank (MTB) -- also headquartered in Buffalo, N.Y. -- saw its NIM expand to 3.75% in the third quarter from 3.68% the previous quarter, and 3.67% a year earlier. The sequential margin improvement "was predominantly due to a $1.6 billion increase in average loans and leases, largely offset by declines in average balances of lower yielding money-market assets and investment securities," according to the bank.

How Low Can Margins Go?


With the Fed continuing to pump money into the economy while boosting demand for U.S. Treasuries to clamp down on long-term rates, JPMorgan analyst Vivek Juneja on Friday said that "banks' ability to offset declining asset yields remains difficult and is exacerbated near term by high mortgage loan refinancing activity and the large amount of deposits invested in liquid assets. With the Fed now expected to hold interest rates flat through mid-2015, we expect NIM pressure to continue throughout 2013 and 2014 for most banks."

Citigroup analyst Keith Horowitz on Thursday published a report showing "shocked NIMs" for each of the large-banks under his firm's coverage, "simulating the impact if all assets and liabilities reprice at today's current market rates," incorporating "detailed surveys of current loan and securities yields, deposit rates and long-term debt yields." The analyst said that on average, "we find shocked NIMs for the group fall to 2.78% from 3.33% in 3Q12."

Horowitz said that he saw the greatest risk to consensus net interest margin estimates for KeyCorp, U.S. Bancorp ( USB) and First Horizon National ( FHN), saying that for these three companies "In each case, the consensus forecast for cumulative NIM decline through 2014 points to below average NIM compression risk relative to peers while our 'shocked NIM' analysis points to average or above average risk."

On an "absolute basis," Horowitz estimated that PNC Financial Services Group ( PNC), BB&T ( BBT) and Wells Fargo will show the sharpest net interest margin declines, "but we believe investors are largely expecting these names to have the most downside."

The analyst also said that JPMorgan's 2014 earnings estimates for large-cap banks "reflect the current forward curve which suggests gradual rising rates. But if we assume the current rate environment remains unchanged, our 2014 estimates would fall on average by ~8%."

Under Horowitz's "shocked" rate scenarios for its big-four competitors, based on third-quarter balance sheets, it estimates that Wells Fargo could see its net interest margin narrow to 2.84%, while JPMorgan Chase's margin could narrow to 2.20% and Bank of America's NIM could dip as low as 2.12%, which is the lowest among the banks covered in his report.

The analyst's "shocked" net interest margin estimate for PNC was 2.82%, while the estimate for BB&T was 3.11%.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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