2022 NIM Improvement

Chad McKeithen, Managing Director, Bank Strategies Duncan-Williams Inc (Division of SouthState Bank Correspondent Group)

2021 Kentucky bank ROA is on a course to average the highest level it has been at in over a decade. Through September, Kentucky banks have averaged a 1.22% ROA. The only year it was anywhere close was in 2019, at 1.13%. Over the past decade, the average ROA in Kentucky was below 1.00%. So, 2021 has been a good year.

The problem is that the performance can’t be replicated. A large percentage of the revenue was from PPP fees, historical mortgage refi fees, and recapturing loan loss reserves--very little of this year’s revenue was from fundamental bank revenue sources.

In fact, if we dig deeper, we can see that net interest income (NIM) is at its lowest point in ten years. NIM is 3.49% compared to 3.74% over the past decade through the third quarter. With stimulus-related revenue declining, net interest income generation will be critical in 2022.

The two prevailing issues that will continue to pressure NIM next year are low loan growth and stubbornly high levels of cash/liquidity. Cash and cash equivalents are currently 11.64% of assets. That compares to a pre-covid level of about 6.38%. With overnight rates close to zero and expected to remain low through much of 2022, it will be a tremendous revenue drag on a sizeable segment of assets, while liquidity does not appear to be leaving any time soon.

The positive news is that short-duration bonds yields have improved immensely over the past three months. This provides a revenue bridge for banks wanting to improve 2022 NIM but not eager to take on interest rate risk. For example, the 3yr Treasury has risen to almost 1.00%. In fact, it is where the 15yr Treasury bond yield was one year ago.

Many agency-backed bonds yield 1.25% to 1.50% for 3-year durations. This short-term bonds yield improvement is giving bankers one of the quickest improvements to NIM, and because Agency and Treasury bonds are so liquid, they can be sold if there is a run on deposits or loan growth picked up. We highlighted a before and after scenario in the table above to highlight the opportunity.

On the left, we can see a bank with 12% cash to assets and a yield on earning assets of 3.76% (current average in KY). On the right, we took the same position but shifted the cash back to 6% and invested 6% in bonds between 1-5 years with a yield of 1.50%. With COFs at 0.37% (current average in KY), we can see that it immediately improves NIM from 3.39% to 3.48%. An immediate increase of almost 10bps to NIM is relatively substantial for not taking on much interest rate risk in the current environment.

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