The Real Problem with Banks’ Profit Margins: Interactive Graphic

Lending is still a pretty good business.

Intense competition and historically low net interest margins notwithstanding, margins on loans themselves are relatively healthy.

Across the industry, loan yields exceeded banks’ cost of funds by 4.54 percentage points in the first quarter, or a wider margin than has prevailed for most of the past decade.

It’s the compression in securities margins, combined with the growing representation of securities on bank balance sheets, that have squeezed the gap between the yield on total earning assets and the cost of funds — or the overall net interest margin — to 3.27%, the lowest level since late 2006. (The following graphic shows data on asset margins and shares on balance sheets industrywide and at small banks. Interactive controls are described in the captions. Text continues below.)

Big banks make up 80% of industry assets, so their characteristics dominate industrywide figures. Yet the picture is similar for small banks.

For institutions with less than $10 billion of assets, margins on loans have been roughly flat since late 2011, holding at higher levels than have prevailed for most of the past decade. Loan yields have dropped — and there is reason to worry about competitive pressure and weakening underwriting standards — but funding costs have fallen faster. (This analysis makes the artificial assumption that any dollar borrowed can be used to fund any dollar invested, whether in securities, loans or otherwise.)

Margins on securities have traveled in a wider range than margins on loans since the early 2000s. Securities margins have generally fallen since 2009. At the same time, securities have helped to fill the vacuum left by loan balances that shrank through mid-2011 industrywide and through early 2012 for small banks.

Industrywide, average securities increased by about 4 percentage points to 29% of total earning assets as of the first quarter this year, while at small banks they increased by about 5 percentage points to 25% of total earning assets. (Securities here include trading account assets, which make up an insignificant piece of portfolios at small banks.)

Historically, securities holdings have played a larger role at big banks, and their net interest margins have generally been lower.

At small banks, growth in margins on loans offset pressure from securities from early 2009 through the third quarter of 2011, as net interest margins expanded 41 basis points to 3.87%. NIMs have since fallen by 21 basis points to 3.66%.

Assuming the same loan and securities margins, if loans’ share of small bank balance sheets in the first quarter had been at the recent high of 78% seen in late 2008 (replacing an equivalent share of balance sheet space taken up by securities), the aggregate net interest margin for the group would have been 3.93%.

Such variables do not move in isolation, of course: rapid growth in both loans and securities in the early 2000s was accompanied by compression in loan and securities margins. But the calculation does illustrate the importance of asset mix to the low profit margins banks are posting.