JPMorgan Chase & Co. (NYSE:JPM) complains of “lower deposit margins.” Citigroup Inc. (NYSE:C) calls it “spread compression.” I like that term better–you can practically feel the bank getting squished between encroaching interest rates.
It has a lot to do with net interest margin. Banks live by net interest margin. When you take your hard-earned paycheck and deposit it into your local bank, that money doesn’t sit around. The bank uses your money as loan material to generate interest revenue. In return for the use of your money, you get paid a small interest rate on your deposit. The difference between the deposit interest rate and the loan interest rate is net interest margin. That’s how a bank makes money.
Here’s a fun graph. These are the quarterly net interest margins of U.S. banks since 1984.
Now picture a bank like JPMorgan Chase & Co. (NYSE:JPM) or Citigroup Inc. (NYSE:C) trying to make a profit in the space between the blue line and the bottom of the graph. (I know, the bottom of the graph is 3.0%, not 0%, but just play along.) Follow the line to 2013. See how tight that space is? That’s spread compression.
You know what’s even more astonishing? In almost 30 years, the only other time that net interest margin was this low was in the fourth quarter of 2008 when the market crashed. No, I’m not making any wild-eyed predictions about imminent doom. I’m just saying that banks aren’t exactly feeling the economic recovery.
Profits running off
JPMorgan Chase & Co. (NYSE:JPM)’s consumer and community banking segment experienced a 6% drop in revenue this past quarter. Not surprisingly, net interest income for the segment was down because of “lower deposit margins and lower loan balances due to portfolio runoff.” Portfolio runoff occurs in a mortgage-backed securities (MBS) portfolio when loans prepay.
That sounds confusing, so here’s an example. When interest rates fall or home values rise, homeowners want to refinance their homes to either lock in a better rate, or to “monetize” the new equity in their homes. Refinancing pays off the previous loan in full, meaning that the mortgage portfolio is stripped of interest income. So, not only is JPMorgan Chase & Co. (NYSE:JPM) squeezed by falling interest rates, it is also bleeding out portfolio value of mortgage-backed securities as customers rush to refinance their homes.
These troubles will continue for JPMorgan as long as the Fed keeps rates unnaturally low. When the Fed cuts back on buying so many bonds, that could be the right time to buy into JPMorgan Chase & Co. (NYSE:JPM), because interest rates will start to rise again.
Loans running away
“Spread compression globally and consumer de-leveraging in North America” flattened revenue growth for Citigroup Inc. (NYSE:C)’s global consumer banking segment in Q1 2013. We already talked about spread compression, but what is “consumer de-leveraging”? It’s actually just households deciding to pay off debt. Consumer de-leveraging hurts banks because banks will have fewer income streams from outstanding loans.