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US bank margins jump in Q3, mark quickest expansion in more than a decade

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US bank margins jump in Q3, mark quickest expansion in more than a decade

Rapid tightening by the Federal Reserve boosted bank margins from depressed levels in the third quarter.

The central bank increased the target fed funds rate 300 basis points through a series of rate hikes between mid March and late September. Those rate hikes resulted in deposit costs rising much more quickly in the third quarter than they did a quarter earlier, though loan yields also continued to surge higher.

The median, taxable equivalent net interest margin for the banking industry jumped to 3.48% in the third quarter, up 25 basis points from the second quarter and the largest quarter-over-quarter increase in more than 10 years.

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Higher rates pressure deposit costs, slow loan growth

Additional margin expansion could prove tougher to come by as deposit costs continue to reprice higher and loan growth appears to be slowing. The Fed raised short-term rates by another 75 basis points in early November and is expected to raise rates by at least 50 basis points at its December meeting.

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The banking industry's aggregate cost of deposits rose to 0.53% in the third quarter, up nearly 34 basis points from a quarter earlier.

Loan growth, meanwhile, slowed in the third quarter, rising 1.0% from the previous quarter, excluding loans made through the Paycheck Protection Program, compared to a 3.9% linked-quarter increase in the second quarter.

On the other side of the balance sheet, deposits continued to decline, falling 1.6% on a sequential basis after posting a 1.9% linked-quarter decrease in the second quarter.

The industry's loan-to-deposit ratio nearly reached 62%, rising for the second consecutive quarter. However, it was still 10 percentage points below the pre-pandemic level recorded at year end 2019.

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Loan yields up, but slower growth may lie ahead

Banks have insinuated that slower loan growth could continue, especially if the broader economy falters.

The Fed's latest Senior Loan Officer Opinion Survey, published in October, show that banks continue to tighten underwriting standards on virtually all loan products. Most banks in the survey assigned a probability of greater than or equal to 40% that the economy would fall into recession within the next 12 months. They expect to tighten lending standards further if a recession materializes.

However, the Fed's H.8 data, which tracks commercial bank balances on a weekly basis, shows that loans in the fourth quarter have been up 1.3% through the week ending Nov. 16. Deposits, meanwhile, inched slightly lower during the same period.

Loan yields in the third quarter climbed 56 basis points sequentially. Additional rate hikes by the Fed should drive commercial and industrial yields, and yields on other credits tied to the short-term rates, higher in the future.

Margins have also been supported by institutions reducing exposures to lower-yielding assets, such as cash and noninterest-bearing balances and interest-bearing balances due, or deposits at other banks. Those assets jumped during the height of the COVID-19 pandemic, but dropped again in the third quarter, falling 8.2% and 4.6%, respectively, from the prior period.

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