US bank margins continue to take a beating

U.S. bank margins drifted even lower in the second quarter as institutions' balance sheets remained bloated with excess liquidity.

The banking industry's aggregate taxable equivalent net interest margin dropped to 2.47% in the second quarter of 2021, down 6 basis points from the prior quarter and down 27 basis points from the year-ago period.

The median margin across the industry dipped to 3.28%, from 3.31% in the first quarter, while the median among the 20 largest U.S. banks fell to 2.02%, from 2.10% in the prior quarter.

Margins were hit again by persistently low rates and a glut of cash fueled by explosive deposit growth. Loan growth, meanwhile, remains hard to find as borrowers continue to hold excess cash levels.

Through the first six months of 2021, deposits rose 17.0% from the year-ago period, building on the historic growth recorded since the beginning of the pandemic. Since year-end 2019, deposits have grown nearly 29%, while loans have increased just over 3% during the same period.

More recently, loan growth has shown some signs of life when excluding loans made through the Paycheck Protection Program, as a number of those credits have been forgiven. When excluding PPP loans, loans increased 1.7% from the prior quarter but just 0.3% from year-ago levels.

As deposits continued to flood bank balance sheets, the industry's loan-to-deposit ratio plunged to 57.97% in the second quarter from 64.80% a year earlier and 72.36% at year-end 2019.

Deposit growth has shown no signs of slowing as the Federal Reserve's monetary policy remains accommodative, while consumers and commercial customers continue to hold higher levels of cash. Since the end of the second quarter, the Federal Reserve's H.8 report, which tracks commercial bank balances, shows that deposits continued to grow through the week ending July 28, increasing 3.4% since June 30.

Deposit growth has been further bolstered by the Federal Reserve's accommodative monetary policy. Government stimulus has supported deposits as well, sending U.S. savings rates above 12% every month since April 2020. Before the pandemic began, the monthly savings rate exceeded 10% just once since January 2000.

Deposit growth has also been supported by PPP borrowers parking the funds they received. While small-business borrowers used some of those funds, bankers have said that deposit balances crept back up after PPP loans were forgiven. Some institutions have said that commercial borrower behavior appears to have changed after coming under stress during the pandemic. Now, some of those commercial customers want to operate with less leverage and plan to hold more cash at the bank going forward.

Banks do not appear to have deployed much of the excess liquidity since the end of second quarter of 2021, either. The Fed's H.8 data shows that loans had barely grown since the end of the first quarter through the week ended July 28.

The few new loans made have carried low yields due to historically low interest rates. Loan yields were under greater pressure throughout 2020 when PPP loans were responsible for the bulk of loan growth in the period, as those credits carried rates of just 1%. The program offered small businesses low-rate, forgivable financing, provided that borrowers use a majority of the funds for payroll. While the loans carry low rates, the credits represented a smaller threat to loan yields in the second quarter as the PPP forgiveness progressed. Once PPP loans are forgiven, lenders are expected to record fees of about 3% on average.

The PPP forgiveness bolstered yields on commercial and industrial credits, which rose to 3.90% in the second quarter, up 7 basis points from the linked quarter and up 28 basis points from a year earlier. Yields on other asset classes declined, though, as higher-yielding loans that were originated before interest rates plunged were paid off or matured.

The industry's loan yield dipped to 4.26%, from 4.32% in the first quarter and 4.46% a year ago.

Margins were also negatively impacted by banks putting more funds to work in low-yielding assets like interest-bearing balances due — deposits at other banks — which have jumped 23.3% year over year off an already high base. Interest-bearing balances jumped in the early days of the pandemic as banks parked the flood of deposits at the Fed. The low-yielding assets have continued to rise notably since then due to the lack of attractive opportunities to put cash to work. Since year-end 2019, interest-bearing balances due have jumped more than 125%.

Banks have continued to grow their securities portfolios at an elevated rate, increasing those portfolios 4.5% from the prior quarter and 26.8% from year-ago levels. Yields on new investments likely have improved, with the average yield on the 10-year Treasury having increased 27 basis points in the second quarter from the linked quarter. The increase in the benchmark rate built on strong increases in the 10-year Treasury yield recorded in the first quarter.

Further increases in long-term rates could help bank margins stabilize soon, but the key profitability metric is unlikely to rise materially until loan demand returns in force, allowing banks to deploy their excess liquidity.