Tuesday, December 01, 2020

Could Net Interest Margin Woes Spell Opportunity?

When an in-person strategic planning retreat has to be hastily switched to a virtual one, sacrifices must be made. And in this case, I simply didn't have the time to review the long-term implications of the Fed's guidance that they were not inclined to raise the Fed Funds Rate until inflation hit or passed 2%. And they didn't anticipate that until 2023.

So we're in this environment together. Negative rates are not likely. Fed Chairman Powell is against that approach. The change from 2.25%-2.5% in 2019 to the 0%-0.25% year to date has resulted in the revenues per product to go down in all deposit products with the exception of money market accounts (see table).

The table is from my firm's profitability peer database, where we measure product profitability for dozens of community financial institutions. The above are peer averages.

The net revenue decline in business loans makes sense because these portfolios tend to have a high proportion of variable rates. What we learned from 2007-08 was to put floors in them, so hopefully the downward trend won't continue. Residential mortgages net revenue went up although we intuitively know that the 30-year rate has gone down. But for measuring product profitability, this number represents what the bank portfolios. Which is probably very little given the rate environment. The coveted gain on sale revenues from secondary market activities goes in the secondary market product, and the residential mortgage line of business.

In 2009, being armed with the above product profitability data, plus the profit trends in their branches, the very large financial institutions began closing branches en-masse. And since the floor fell out on the Fed Funds Rate this year, several including PNC, Wells, and US Bank announced more accelerated closures. From March through August, banks submitted closure requests to regulators for 893 branches. During the same time last year, 967 were submitted. So there was an 8% drop.   

But I think, faced with the declining revenues and their high depositor retention from past closures, more will be announced. Does this signal an opportunity for the financial institution with a long-term view to aggressively pursue core deposits in the face of reduced short-term profitability of those deposits? Especially if the bank could put those deposits to work at some positive spread, which we have to believe we can. 

It wouldn't bode well for your net interest margin. But could certainly generate growth in net interest income. And position your bank for the often repeated cycle of positive economic growth where loans grow faster than deposits for multiple years. When that happens, your competitors will start offering $400 for customers to switch deposit accounts. 

But you would have already won them.

~ Jeff

Note: The above data was taken from my firm's profitability peer database. If you want to learn how you can measure product profitability, line of business profitability, or customer profitability, click here.  

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