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Falling Securities Portfolio Yields To Pressure NIM

 November 23, 2012 10:09 AM

(By Mani) The Federal Reserve's recently expanded mortgage-backed securities (MBS) purchasing activity has contributed to a significant decline in MBS yields and could pressure bank's net interest margins.

The year-to-date average yield on Fannie Mae's current-coupon mortgage bonds stands at about 2.49 percent compared to 3.67 percent in 2011.

Banks have managed to limit the impact of lower yields on earning assets through favorable deposit repricing, holding municipal and corporate bonds that offer slightly higher yields, and modest loan growth.

"As a floor is reached on the cost of liabilities, however, we expect the persistent low interest rate environment to pressure banks' NIM," RBC Capital Markets analyst Gerard Cassidy wrote in a note to clients.

[Related -Prosperity Bancshares: EPS Volatility, Core NIM Pressure Makes M&A A Necessity]

Average interest income from MBS as a percentage of total net interest income declined to 14.1 percent in the third quarter of 2012 from 20.9 percent in 2009. The decline has been especially pronounced for custody banks due to the fact that they derive a larger percentage of their interest income from securities portfolios vs. Commercial banks.

Meanwhile, MBS interest income as a percentage of average earning assets has steadily declined for the industry over the last five years to 39 basis points (bps) in the third quarter from a high of 61 bps in 2008.

Prosperity Bancshares, Inc.'s (NYSE: PB) MBS income to earning assets was the highest at 97 bps while Zions Bancorp (NASDAQ: ZION) had the lowest at 2 bps. International Bancshares Corp. (NASDAQ: IBOC) has experienced the greatest decline over the last five years, falling 97 bps to 79 bps while Webster Financial Corp. (NYSE: WBS) has experienced a 39 bps improvement over the same period.

[Related -Housing Recovery Bodes Well for Banks]

"For the top 50 banks, the average yield fell to 2.51% in the 3Q12 from 5.88% in 2008," Cassidy said.

In the chase for yield in an environment of stagnant loan growth, banks have increased their reliance on securities portfolios. The proportion of MBS holdings to assets increased to an average of 16.3 percent from 11.2 percent in 2007. From 2007 to the third quarter of 2012, the average percentage of MBS holdings to total securities increased to 68.4 percent from 63.5 percent.

"We expect NIM pressure to persist given the Federal Reserve's commitment to keeping rates low through late 2014," Cassidy noted.

As a result, banks with the large MBS portfolios with high premiums could be exposed to higher refinancing risk. That said, if the U.S. economy improves more quickly than expected and rates begin to rise, banks with large securities portfolios could potentially incur unrealized losses. In addition, Tier 1 common ratios would be impacted.



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