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US bank margin expansion stalls

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US bank margin expansion stalls

Competitive pressures have limited increases in loan yields, causing U.S. banks' net interest margins to contract in the first quarter.

Despite continued increases in both short- and long-term rates in the first quarter, loan yields only moved modestly higher. Banks competed for the quality credits they could find as loan growth remained weak in the period. Deposit costs, meanwhile, rose by greater amounts from the prior quarter, pushing margins down for the first time in five quarters.

Banks' fully taxable-equivalent net interest margin dipped 1 basis point to 3.29% in the first quarter of 2018 from 3.30% in the linked quarter but rose from 3.17% a year earlier.

The banking industry's margin remains considerably higher than the recent low point sustained in the first quarter of 2015. Margins were under pressure between 2012 and 2015 due to persistently low interest rates and fierce competition for quality credits that caused many banks to lower prices on loans.

After years of pressure, loan yields finally began rising in in the second half of 2017, buoyed by a roughly 70-basis-point increase in key short-term interest rates, such as the London Interbank Offered Rate throughout 2017.

Short-term rates continued to move higher in the first quarter, helping lift the banking industry's yield on loans and leases to 5.05%. Loan yields finished the period 34 basis points higher than year-ago levels, but only rose 5 basis points from the linked quarter. Modest expansion occurred, even as the average three-month LIBOR and 10-year Treasury yield finished the first quarter notably higher than end-of-2017 levels.

Yields on commercial and industrial loans rose the most in the first quarter, given that those credits are usually tied to the short end of the yield curve, but competition prevented yields from rising in step with increases in short-term rates.

Bankers said in the Fed's recent quarterly senior loan-officer survey that spreads on C&I credits to larger and middle-market firms, relative to their cost of funds, contracted for the 33rd consecutive quarter. That survey featured responses from 72 domestic banks and 22 U.S. branches and agencies of foreign banks and focuses on changes in lending standards and terms.

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In the survey, a net 24% of banks responding reported weaker spreads on C&I loans to large- and medium-sized firms, relative to the lenders' cost of funds, up from 16% in the last quarterly survey, published in January.

S&P Global Market Intelligence found in a separate analysis of the nonsyndicated commercial loan market that average spreads declined for both higher-rated credits and some lower-rated loans.

The average spread above LIBOR for higher-rated credits declined to 207 basis points in March, down 5 basis points from a year earlier. The average spread for a lower-rated borrower fell to 268 basis points, 16 basis points lower than a year earlier.

Yields on loans tied to long-term rates appeared to be under greater pressure. The yield on the 10-year Treasury has jumped from the recent lows in early September, rising 71 basis points through the first quarter as investors reacted to rebounding economic growth and stronger inflation stemming from the passage of federal tax reform.

Despite the resurgence in long-term rates, yields on longer-term credits such as one- to four-family mortgages and some commercial real estate failed to move notably higher. In the first quarter, the yield on CRE loans rose just 1 basis point from the linked quarter, while the yield on one- to four-family mortgages actually declined 1 basis point.

Interest rates are expected to move higher, but lending growth likely needs to rebound for banks to see material increases in their loan yields. Deposit costs, meanwhile, continue to grind higher, with the cost of interest-bearing deposits rising another 6 basis points in the first quarter.

The deposit beta, or the percentage of changes in market rates banks have to pass on to their customers, rose to roughly 30% in the first quarter, up from the nearly 20% level experienced in 2017.

As funding costs continue to rise and loan yields remain under pressure, it continues to hold true that the banks with the strongest deposit franchise will be those best positioned to see their margins expand in 2018.

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