Lowell-based Butler Bank, which reportedly has the second-highest net interest margin among Massachusetts banks, has its focus on short-term loans to thank for that position.
Massachusetts banks have watched net interest margins decline over the last decade. Some industry watchers say they are about as low as they can go, and others say the shrinking margins have added to the competitiveness of the banking business. As attracting core deposits becomes more of a challenge, short-term interest rates go up and bankers are faced with a flattening yield curve, net interest margins feel pressure.
NIMs – the difference between the rate at which banks can obtain funds and the rate at which they lend them out – are directly tied to the institutions’ profitability. Because NIMs are closing in, there is a greater need for banks to attract deposits since it is less costly than borrowing funds from outlets such as the Federal Home Loan Bank. However, the competitive landscape in Massachusetts also is making it harder for banks to attract deposits at a time when they are in such high demand, according to industry experts.
The median NIM for financial institutions in Massachusetts dropped from 3.5 percent in 2004 to 3.46 percent in the fourth quarter of 2005, according to the Federal Deposit Insurance Corp.’s recently released state profile. According to the FDIC, the median NIM nationwide rose slightly from 4.02 percent to 4.08 percent at the end of 2005. Massachusetts has lagged behind the national NIM for more than 10 years.
“The rest of the country has a fairly steady net interest margin,” said Paul Driscoll, regional manager of the FDIC’s Division of Insurance and Research. “But everywhere in the country is under some pressure from the flat yield curve.”
The Federal Reserve Board has raised interest rates 15 times during its last 15 meetings by 25 basis points each time. Driscoll said there will most likely be a lag effect when the Fed does stop raising short-term interest rates before the NIMs increase. He said banks also will keep their lending rates low as long as they can to ensure they are a competitive option for consumers.
The state profile also notes an increase in Massachusetts banks turning to non-core sources such as borrowing to fund growth. Non-core funding can be expensive, further tightening NIMs. At the end of 2005, Massachusetts banks had the 12th highest non-core funding-to-asset ratio at 24.51 percent, according to the study.
Driscoll, who worked on the FDIC’s state profile for Massachusetts, said it is important to add that capital for banks in Massachusetts to remain at healthy levels. He said banks may have to work harder or pay more for their funds, but it does not mean the institutions are in danger.
“It’s harder and harder to get lower core deposits,” he said.
Normally, banking trends tend to work in cycles. Driscoll said NIMs are bound to increase at some point. However, greater competition makes it somewhat of a cyclical decline, he said.
“The basic business of banking is getting tougher,” said Driscoll.
‘Very Hungry’
John Carusone, president of the Hartford, Conn.-based Bank Analysis Center, said the banking industry in Massachusetts is among the toughest in which to compete. He said the competitive nature of the business, plus the added squeeze to NIMs, makes it an even harder marketplace.
“The margin compression has emphasized the need for earnings,” noted Carusone.
And bankers throughout the commonwealth are noticing the change.
John Pearson Jr., president of Lowell-based Butler Bank, said it would be harder for his bank to attract deposits if it did not have the high NIM that it does. According to the Bank Analysis Center, Butler has the second-highest NIM in Massachusetts. Pearson said if his bank is feeling the squeeze, he knows the other institutions are as well.
Most banks tend to borrow short-term and lend on a long-term basis, which is why a flattening yield curve compresses NIMs.
Butler Bank primarily focuses its lending on short-term loans. Pearson noted that it is a bit of a niche market, since most banks tend to do the opposite. Knowing his bank’s business model is ideal for following rate hikes, he said he is more than happy to see the Fed raise rates. Lending out money on a short-term basis allows Butler to adjust its own rates on a more regular basis than most of its competition. According to Pearson, that is what has kept the bank grouped with financial institutions that have the highest NIMs.
But not every bank is in the position of Butler.
Jim Jones, president of First Wellesley Consulting, said increased pressure to NIMs and intense competition are two major challenges that greatly impact the industry.
“The implication to the industry is reduced profitability,” said Jones. “Sheer competition has driven down loan rates and driven up [savings and checking] interest rates. The banker has had to sharpen his pencil at both ends.”
Jones said banks are looking for alternatives to supplement their income with new types of business such as financial planning, insurance and investment services.
“Banks are still making money. The profitability just isn’t what it used to be,” said Bob Segal, chief executive officer of J. William Mantz Investment Advisors in Gloucester.
Segal said there has been a push in recent years not to rely so heavily on NIMs for profitability. He said more banks are expected to consider perusing new business avenues such as insurance or investment services. But Segal warns bankers need to be careful not to spread themselves too thin if they decide to follow through with some of the business options out there.
Industry watchers also note that financial institutions are offering several “specials” to attract deposits, such as CDs with high returns.
“Banks are very hungry for deposits,” said David Floreen, senior vice president of the Massachusetts Bankers Association. “You need to raise rates to attract deposits. We have a very competitive marketplace.”
Arlington-based Leader Bank reportedly had one of the lowest NIMs in the state at the end of 2005, according to the Bank Analysis Center.
Sushil Tuli, president of Leader Bank, said now is the time for banks to come up with creative ways to attract deposits. Tuli said consumers have become smart shoppers, which means banks need to work harder for their business. He said consumers will shop around for specials but not for a new bank.
About a month ago Tuli’s bank launched a new type of home equity loan which requires that the loan money goes into a Leader checking account and that payments also must be made through the account. He said such a method will ensure people are actually banking with Leader, not just taking advantage of a special.
“The key is to get people to open checking accounts and keep money in there. The key is to make people use those checking accounts,” he said.
Tuli said the bank already has done $6 million worth of business through the program.
Although Tuli said he is aware pressure on NIMs hurts a bank’s profitability, he said it is just one of the aspects that make banking in Massachusetts harder than in other states. “When you get into banking, you have to be prepared for this,” said Tuli.
Floreen said local bankers are facing tremendous cost pressures, and it’s tough for banks to thrive during a time when NIMs are tightening.
“That’s reality. It’s basic economics,” he said.
