It is probably not news to you that financial institutions are in a unique and challenging rate environment. As writers and advisors we often overstate the difficulty and challenges of any current environment. For example, no matter what anybody said about rates and the economy in 2015, it was still incredibly cheap to borrow money, whether from depositors or from wholesale markets. But today’s environment is especially challenging.
Even before the Fed rate cut in July, mortgage rates were starting to drop and now have fallen to their lowest levels in three years. Prime- and LIBOR-based loans are earning about 50 basis points less than earlier this year, and those yields are certain to drop again if the Fed cuts rates again this fall. But borrowing, in the form of cost of funds, hasn’t really gotten any cheaper yet. And unlike 2012, if loan demand increases due to lower rates for consumers, deposit costs are not likely to decrease as much because liquidity, or available excess deposit funding, has mostly dried up over the past five years. This demand for retail deposits is keeping deposit rates higher than they typically stay when wholesale rates start to drop. In short, a nasty squeeze is being applied to your net interest margin.