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 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.
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.