Margin Pressure Expected to Persist this Year

Analysts at A.M. Best predict that the banking industry will find it difficult to increase net interest margins this year, even if the Fed holds off on further interest rate increases.

With loan losses creeping up, "erratic performance" of trading income at large institutions and increased competition for both deposits and loans are conspiring to keep the cost of funds high and asset yields low. Moreover, residential mortgage lending may continue to lose steam as an earnings driver for banks, according to the report.

And those trends will persist for banks that hold mortgage assets and other loan products on their books, A.M. Best predicts.

The banking analytics firm notes that while the banking industry remained strongly profitable in the third quarter, the number of banks reporting gains in earnings has declined steadily since peaking in the summer of 2005, A.M. Best said.

The report goes on to say that "underlying shifts in the balance sheet mix and operating statements of U.S. banks suggest a trend toward higher levels of credit and interest rate risk in various segments in the industry."

So far, banks have managed the net interest margin contraction well, benefiting from stable economic conditions and their ability to draw down loss reserves and boost fee income.

A.M. Best said the industry continued to experience loan growth related to real estate, but the balance was shifting more toward commercial lending than consumer lending. Industrywide, loan growth in construction and land development increased 29.47%, and commercial real estate lending grew 9.14% last year. Meanwhile, the loan growth rate for single-family residential property loans was only 6.83%.

That continues a trend dating back to 2003, when construction and development as well as commercial real estate loan growth first outpaced residential loan growth.

A.M. Best noted that consumer debt service burdens, measured as a percent of personal income, are at a record level, according to the Federal Reserve Board. That may constrain home loan growth. The slowdown in home price appreciation also may be slowing down residential mortgage growth.

A.M. Best also noted that mortgage delinquency levels have increased. Total delinquent single-family residential mortgage debt increased by about $7.8 billion, or 20%, in the third quarter to $47.7 billion. Non-accrual home loans held on bank balance sheets increased by $3.1 billion.

Other types of consumer lending, including credit card debt, have also experienced slower growth.

Snapshot: Bank Loan Growth Rates in '06

Construction and Land Development 29.47%

Commercial Real Estate 9.14%

One-to-Four Family Residential 6.83%

Source: A.M. Best & Co. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com

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