Banks Battle The Big Squeeze

Tight loan margins spur hunts for ways to generate profitsSUMMIT – Faced with thinning margins on their lending, bankers are furrowing their collective brows to come up with ways to operate more efficiently and ferret out new sources of revenue to help offset the drop in interest earnings.

“There’s definitely an issue here: Flat earning pose a threat for all banks,” says Carlos Migoya, chief executive officer of Wachovia Bank’s Atlantic region, where he oversees roughly 480 bank branches in New Jersey, New York and Connecticut from offices in Summit and New York City.

While Wachovia officials have reason to cheer the bank’s third quarter profits, which rose to $1.88 billion from $1.66 billion a year ago, they can’t be happy about its shrinking profit margins on loans. Those margins, which represent the difference between what the North Carolina-based bank pays for deposits and what it charges borrowers, fell to 3.03 percent in the third quarter from 3.18 percent in the second.

The dwindling margins reflect the fact that the yield curve—or spread between short- and long-term interest rates—remains unusually flat. Since banks typically borrow short and lend money for longer periods at higher rates of interest, the narrow spread puts a squeeze on profits.

According to the Federal Deposit Insurance Corp. (FDIC), the flat yield curve continues to strain net interest margins (NIM) reported by FDIC-insured institutions. NIM declined to 3.3 percent in the second quarter 2006, down from 3.4 percent one year ago, based on FDIC figures released in November.

One reason for the flattening has been the two-year climb in the federal funds rate—the interest the Federal Reserve charges banks for overnight loans. The Fed has raised the key rate 17 times since June, 2004; the rate has stood at 5.25 percent for the past five months.

In remarks last week, Federal Reserve Chairman Ben Bernanke said the U.S. economy is strong and continues to face the threat of inflation—a strong hint that no rate cuts are in sight.

“The banking industry right now is under tremendous pressure from the yield curve,” says Gerald Cassidy, banking analyst for Portland, Maine-based RBC Capital Markets. “But also, the [banks’] demand for deposits has increased as loan demand has picked up. Banks have been hit by a double whammy: the [flat] yield curve and the intense competition for deposits.”

Cherry Hill-based Commerce Bancorp posted earnings of $79.6 million, or 41 cents a share, for the third quarter ended Sept. 30, compared with $79.4 million, or 45 cents a share, for the same quarter last year. The narrowing interest rate spread reduced the bank’s net interest margin to 3.27 percent compared with 3.39 percent last year.

Provident Financial Services, the Jersey City-based owner of Provident Bank, reported third-quarter net income of $13.0 million, or 22 cents a share, down from $14.9 million, or 23 cents a share, a year ago.“Consistent with the industry trend, our third-quarter operating results reflect the impact of the prolonged flat or inverted yield curve,” says Paul M. Pantozzi, chairman and CEO of Provident Bank.

To ease the profit pressures, most banks are cutting operating expenses and looking for new sources of revenue. “The yield curve hasn’t improved much,” says Thomas A. Bracken, president and CEO of Vineland-based Sun Bancorp, which operates about 80 banks in New Jersey and Pennsylvania. “So bank people are adjusting to it, trying to find other ways to have a positive bottom line.”

For the third quarter that ended Sept. 30, Sun reported net income of $4.9 million, or 23 cents a share, down from $5 million, or 25 cents a share, for the year-ago period.

Bracken uses fee-based business to help boost profit margins. “You can sell investment products to your customers that aren’t deposits, that are more like annuities that will generate you some fee income,” he says. Similarly, “you can generate a home mortgage and generate a fee for passing that on to a long-term lender who is going to hold that mortgage.”

Meanwhile, “We’ve taken a very hard look at our expenses and really tried to eliminate as much unnecessary expense as we have,” says Bracken. “There’s not much you can do about the cost of your real estate. But people are always an ongoing issue because the two biggest expenses that any bank has are real estate and people, other than the cost of money.”

Sun’s cost-cutting moves include the June layoff of 80 workers, or about 10 percent of its work force, and the October sale of three Sun National Bank branches to reduce overhead.

Like Sun, Migoya of Wachovia stresses fee-based strategies. “In our case at Wachovia, we’ve gotten to the point that a big percentage of our business is fee-driven business, meaning brokerage business and other kinds of fee business,” says Migoya. “You can’t do this by going out and marketing six percent CDs [certificates of deposit]. That would only worsen the situation because you are going to have tighter margins.”

He takes comfort in the fact that the Federal Reserve did not raise interest at its two most recent meetings. “If the last two times they didn’t increase [rates] is an indication that going forward that they might start dropping [rates], it would have been a great situation,” Migoya says. “But it doesn’t look like that’s going to happen anytime soon.”

Experts say the key issue is how long banks can maintain healthy profits while waiting for interest-rate spreads to widen. Says Cassidy: “The question becomes, will [banks] be strong enough to get through it so that when the deposit competition lessens and the yield curve becomes normal, they can go back to earning money the old fashioned way—from the profit spreads between their assets on one side of the balance sheet, and their liabilities on the other side.

E-mail jmcconville@njbiz.com

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