Net interest margin
For banks and other financial institutions, the main source of revenue is the interest earned on loans. A bank’s primary function is to accept deposits from customers and lend out the money to borrowers. Generally, the bank pays a lower rate of interest on deposits. It charges higher interest on loans granted. The difference in the interest earned and interest paid is the bank’s net interest income.
For a bank, the NIM (net interest margin) is the difference between the interest income generated and the interest paid out as a percentage of interest-earning assets. It’s the most common metric used to determine how effectively a bank is using its earning assets. The higher the ratio is, the better.
Interest margins in an increasing rate environment
Typically, net interest margins trend higher in an increasing interest rate environment. In an increasing rate environment, the interest income produced by floating rate loans increases. Income from short-term securities held in banks’ portfolios also increases. The banks shift them to higher rates.
Eventually, banks have to start paying higher interest on their deposits. Also, shifting balances from noninterest-bearing to interest-bearing accounts has negative impacts on interest margins. Banks raise the interest they charge for loans faster than what they pay on deposits. A rate rise might also indicate an improving economy. This would result in higher demand for loans.
Stable net interest margins
Regions Financial’s (RF) principal source of income is net interest income. Regions Financial’s NIM remained stable even in a low-rate environment. This is largely due to its efficiency in deposit and funding costs, as we discussed previously.
The above graph compares Regions Financial’s NIM with its peers. If the rates remain low over the coming year, it’s expected to put moderate pressure on Regions Financial’s NIM. SunTrust Banks (STI) and Wells Fargo (WFC) had a lower NIM at 2.96% and 3.04%, respectively, in the last quarter. BB&T (BBT) had a higher NIM of 3.36%—compared to Regions Financial. Both of these banks form ~3% of the SPDR S&P Bank ETF (KBE).