Most banks' net interest margins rebounded in the second quarter as loans grew at a quicker pace than in the prior quarter.
Funding costs continued to grind higher, but banks grew loans at a quicker clip in the second quarter and saw the yields on their loans grow as well, leading to stronger margins for most banks. The median taxable equivalent net interest margin of the banking industry expanded 3.35%, up 7 basis points sequentially, after falling 7 basis points in the first quarter and 1 basis point in the 2023 fourth quarter, according to S&P Global Market Intelligence data.
Stronger loan growth supports margins
Loan growth accelerated in the second quarter after contracting in the first quarter. The rebound occurred as the Federal Reserve's most recent survey on bank lending showed that lending conditions were not as bad for borrowers as in the prior quarter. Loans also grew faster as intermediate interest rates declined in the second quarter ahead of expected rate cuts by the Fed. In the period, aggregate loans increased 1.0% from the linked quarter after declining in the first quarter. The median quarter-over-quarter loan growth among banks was even stronger at 1.7% in the second quarter compared to 0.8% in the prior quarter.
Banks have restricted credit in recent quarters by tightening lending standards, while demand has remained weak. Still, fewer banks reported tighter lending standards in the most recent period, according to the Fed's latest Senior Loan Officer Opinion Survey, published in July. The survey showed far fewer banks reporting weaker demand across all major categories, and demand for commercial and industrial loans was flat with three months ago.
While loan growth rebounded, deposits declined in the second quarter as several banks tested the waters and tried to hold or even lower rates on their deposits before the Fed's expected pivot to lowering rates in the second half of 2024. The decline in deposits pushed the industry's loan-to-deposit ratio to 66.7% in the second quarter from 65.4% in the first quarter and 66.2% in the fourth quarter of 2023.
The Fed's H.8 data, which tracks commercial bank balances weekly, shows that loans in the third quarter have inched 0.3% through the week ended Aug. 21. Meanwhile, deposits have climbed modestly as well, rising 0.2% during the same period.
Deposits decline as banks position for rate cuts
Deposits in aggregate dipped 1.0% quarter over quarter as banks tried to control deposit pricing pressure. However, deposit costs rose again in the second quarter, albeit slower, with the median cost of deposits at banks increasing 11 basis points to 1.96% after rising 16 basis points in the prior quarter.
Deposit costs continued to rise as banks faced ongoing regulatory pressure to maintain ample liquidity. Banks have also increased their reliance on certificates of deposits (CDs) for funding, particularly products with one-year terms. As CDs originated in 2023 matured, many banks likely needed to pay market rates to keep that funding, and those rates had not yet declined in the second quarter. The number of banks marketing one-year CDs over 4% stood at 905 as of Aug. 30, compared with 925 at June 28 and 839 at March 29.
The futures market now expects rate cuts soon, assigning 100% probability of a rate cut in September and a 44% probability of rates falling 100 basis points by the December 2024 Fed meeting. Should those cuts occur, banks will feel relief from deposit pricing pressure.
Banks can turn that relief into further margin expansion by maintaining loan growth and redeploying cash flows from their low-yielding securities portfolios into higher-yielding bonds and new loans. If the economy does slow, however, banks could tighten lending standards further or seek to attract new borrowers with fixed-rate loans that carry lower yields while offering institutions some protection against rate cuts by the Fed.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.