Net Interest Margin Trends and Expectations

Much has transpired since Bank Watch’s last review of net interest margin (“NIM”) trends in May 2019.  The emergence of COVID-19 in early 2020 resulted in economic shutdowns that led to emergency rate cuts from the Federal Reserve and unprecedented monetary and fiscal stimulus.  While the economic recession that followed COVID-19 proved to be short-lived, low rates and excess liquidity lingering in the system have weighed on margins.

As 2022 gets underway, the industry is hopeful that rate increases and loan growth, stemming from the continued economic recovery, will deliver a boost to margins.  This potential inflection point provides a good opportunity to review recent margin trends and examine how banks may be impacted by rising rates this year.

Figure 1 :: Net Interest Margin Trend

As shown in Figure 1, NIMs contracted sharply in 2020 and have remained depressed relative to long-term averages.  With deposits accumulating on the balance sheet and a lack of attractive lending opportunities, many banks’ asset composition shifted in favor of short-term, lower-yielding assets.  According to FDIC data, the loan to deposit ratio for community banks reached record lows in 2020 and 2021, reported at 73% as of the third quarter of 2021.  This compares to an average 83% from 2012 to 2019.

Aside from the earning asset mix and deposit base, NIMs reflect a lending margin over a base rate determined based upon competition.  The base rate has been severely depressed, and excess liquidity in the system has squashed any additional lending margin to be had.

NIMs for small community banks (assets $100 million to $1 billion) fell 39 basis points from the fourth quarter of 2019 to the second quarter of 2021, while banks with $1 billion to $10 billion in assets experienced margin compression of 36 basis points over the same period.  We would note that margins have been somewhat distorted by PPP loans and the associated fee income.

The third quarter of 2021 showed some positive trends for NIMs, with both small and large community banks reporting modest expansion of 2 to 11 basis points.  Margins could expand further in the fourth quarter if loan growth materializes and payoffs subside.  Lower premium amortization expense should provide another tailwind for banks with MBS exposure as prepayments speeds decline.

2022 Expectations

Banks are optimistic for 2022 with the Fed winding down its asset purchases and potentially raising rates as early as March. The 30 day and 90 day forward curves for LIBOR imply the Fed will raise rates three to four times by the end of 2022. The 10-year Treasury yield spiked to start the year, settling at 1.78% as of January 25, up from 1.52% at year-end

Figure 2 :: 30/90 Day LIBOR Forward Curve @ 1/26/22

The absolute level of rates is an important factor on the deposit side of the equation, specifically rates out to about 3 years. Higher rates increase the value of non-interest bearing and very low-cost deposits as they provide more lift to the NIM. Banks with a higher proportion of non-interest bearing deposits stand to benefit more from a rising rate

Deposits accumulated during the pandemic have proven to be stickier than many initially thought, and 2022 should provide a good test of that stickiness. As a percentage of total assets, deposits have increased each quarter since Q2-20 for both small and large community banks.

Some banks are concerned about the possibility of deposit run-off with rising rates, but the prospect of deposit run-off significant enough to hinder lending opportunities seems unlikely. Deposit rate adjustments by banks in periods of rising rates tend to lag Fed rate movements. There is reason to expect, given banks’ liquidity, that deposit rate adjustments will have a longer than normal lag in this rate cycle.

Banks that were hesitant to deploy excess cash at low yields should have some opportunities to invest at higher yields in the bond market this year. Anecdotally, some banks reporting Q4-21 earnings have mentioned shifting a greater proportion of funds to the securities portfolio. For example, Independent Bank Corp. (INDB) expanded its securities portfolio by $445 million in Q4-21 and plans to be “aggressive” with securities investments in 2022.

Rising rates notwithstanding, margins may still not return to historical levels due to excess liquidity. For one, loan growth may not be enough to absorb the sheer amount of cash that banks accumulated in 2020 and 2021. In addition, loan pricing reflects a base rate plus a lending margin, as mentioned previously. The base rate will come up, but the additional margin could remain challenged if would-be lenders remain flush with liquidity and the intensity of competition for loans does not wane.

These challenges will likely be a driver of M&A activity this year. Sellers face profitability challenges with continued margin pressure, the loss of PPP fees, and normalization of mortgage income. Buyers may find it more attractive to acquire targets with legacy loan books at better rates versus trying to grow loans organically in the current environment or investing in securities at low yields.

Public Market Perspective

Bank stocks have outperformed since mid-September when investors concluded the Fed was likely to raise rates in 2022 rather than 2023. As of January 26, the KBW Nasdaq Bank Index is up 6.1% from September 15th compared to the S&P 500’s 2.9% decrease.

Analysts are anticipating margins to bottom out in the first quarter of 2022. Smaller rate increases may have a limited near-term impact on loan yields. For example, Bank OZK (OZK) announced in Q4-21 that 63% of its variable rate loans would still be subject to rate floors after a 50bps change in the base rate.

Margins are forecast to begin increasing in subsequent quarters and pick up steam in early 2023. However, margins will likely remain below pre-pandemic levels for the foreseeable future. The chart below shows historical and forecast margin performance for a group of public regional banks.

Figure 3 :: Historical and Forecast Margin Performance for Public Regional Banks

Click here to expand the chart above

Banks with assets between $5 billion and $10 billion traded at 12.6x projected 2022 earnings and 1.60x tangible book value as of January 26. Banks with assets from $1 billion to $5 billion traded at 11.1x projected 2022 earnings and 1.29x tangible book value. Valuations presumably capture the impact of three rate hikes in 2022. As noted earlier, this has been the case since September when investors shifted their expectations for Fed rate actions.


Ultimately, rate increases on the horizon and economic recovery should provide a tailwind to margin expansion in 2022.  However, excess liquidity still presents a challenge, and uncertainty remains as to further impacts from COVID-19.