Fed rate cut negative for bank profitability, can prompt further consolidation: Moody's

The cut in US Fed funds rate is credit negative for American banks, applying renewed pressure on net interest margins (NIMs) and profitability that could stimulate further consolidation of the sector, Moody's Analytics said on Thursday.

A day earlier, the Federal Reserve Board cut the Fed funds rate 25 basis points (bps), reversing one in a series of nine rate rises that began at the end of 2015 and ran through the end of 2018.

"Interest rates are already low by historical comparison and the yield curve has flattened, with a material effect on bank profitability. In particular, the NIMs of rated US banks declined in the second quarter even as the Fed funds rate held steady, and we expect NIMs to weaken further over the remainder of 2019," said Moody's in its credit outlook.

Persistently depressed interest rates and intensifying digital competition could promote additional risk-taking to raise bank profitability as well as spur further industry consolidation.

"However, banks with healthy levels of noninterest income and room to cut expenses should be able to manage these challenges, and most banks' business models will be sustainable unless US interest rates approach zero and remain there for some time," said Moody's.

The average NIM of large US banks climbed 36 bps to 3.23 per cent in Q1 2019 from 2.87 per cent in Q4 2015 when the Fed began to raise rates. As a point of reference, this NIM increase translates to incremental annualised revenue of 360 million dollars for a typical large regional bank with 100 billion dollars of interest-earning assets.

However, average NIM declined seven bps in the second quarter, eroding nearly 20 per cent of the banks' recent margin gains.

The flattened yield curve and the prospect of lower short-term rates threaten to reverse even more of the recent improvement in US banks' NIMs and undermine their overall profitability, given that net interest income accounts for the largest portion of most US banks' revenue, said Moody's.