Margins recover some headroom in Q2

By Kevin Dobbs and Zuhaib Gull, SNL Financial staff writers

Following four years of compression and a notable dip in the first quarter of 2015, banks turned a corner in the second quarter and expanded their net interest margins.

U.S. commercial banks, as a group and on fully taxable equivalent basis, saw their second-quarter NIMs climb to 3.01% from 2.96% in the linked quarter, according to an SNL Financial analysis of regulatory filings. Analysts credited some interest rate and pricing stabilization during the quarter and, more importantly, continued loan growth.

"I would say where you saw the NIM improvement it was mostly due to loan growth," analyst Brad Milsaps of Sandler O'Neill & Partners told SNL.

Recent SNL analyses found that second-quarter loan growth among major banks approached 5%, when compared with a year earlier, while lending expanded nearly 7% among community banks.

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Shift from recent trend

Margins have long been under pressure amid heated competition for loans and a protracted low interest rate environment that dates to the aftermath of the 2008 financial crisis, when Federal Reserve policymakers brought short-term rates down near zero. They have kept rates historically low since.

But in an improving economy—unemployment, at 5.3%, held at a seven-year low in July—more banks have been able to expand lending enough to boost interest income levels to offset NIM pressure. Milsaps added that ongoing merger-and-acquisition activity also has helped buyers beef up their loan books and, in the process, lift margins in some cases.

Net interest income for the commercial bank group approached $101 billion, SNL's analysis shows, up from $98.7 billion the previous quarter.

A majority of the top 20 commercial banks in the U.S. expanded their NIMs during the second quarter, SNL found, including banks run by JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co., and Citigroup Inc.

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Terry McEvoy, a Stephens Inc. analyst, told SNL that many banks were able to put more liquidity into loans—which typically generate higher yields than securities—making their balance sheets more efficient and bolstering their NIMs.

He said demand for loans has been steady in the commercial-and-industrial segment on the business side and in the auto arena on the consumer side. Several banks also have had success carving out niches to capitalize on growth industries such as health care, he said.

Bottom line, McEvoy said, lending activity was strong enough to help prop up NIMs. "That really was the positive takeaway for the quarter," he said.

Loan yields in several categories stabilized in the second quarter, including yields on commercial banks' one- to four-family loans and on consumer loans, excluding credit cards, according to SNL. Milsaps said "it is still a very competitive" landscape for prized borrowers, and that is likely to remain the case. But pricing pressure appeared to level off some in the second quarter.

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Rate outlook remains a question

Long-term rates did gather some momentum in recent months. The yield on the 10-year Treasury finished 2014 at 2.17%, down 87 basis points from the close of the previous year. But by early August of this year, the 10-year yield had settled around 2.23%, providing some assistance for banks under margin pressure.

That noted, analysts say, most banks are looking for the Fed to lift short-term interest rates, a move widely viewed as necessary for lenders to substantially and consistently expand margins in coming quarters.

Many industry observers anticipate that Fed policymakers will begin to increase rates after their September meeting or at least by the end of 2015. But many also are looking for the Fed to move slowly, likely with an initial 25-basis-point bump.

"When they do move, it's going to be slow and measured," Milsaps said.

McEvoy agreed and said that when the Fed does act, the initial benefit to banks could be "modest." But over time, higher rates should bolster the industry's profitability, and that explains why bank investors are eagerly looking for the Fed to move.

"It is," McEvoy said, "the catalyst that investors are waiting for."

This article originally appeared on SNL Financial’s website under the title "Banks' margins recover some ground in Q2'15"