What You Need to Know About Net Interest Margin (NIM)

Before investing in a bank, or in any company for that matter, you should understand the business model the company uses to make money. The biggest banks, known as money-center banks, have multiple business lines and try to make money doing lots of different things.

The vast majority of the thousands of banks in the United States basically try to earn profits by loaning money to their customers and earning interest on those loans. The money they use includes the capital invested by their shareholders, but is mostly -- usually around 90% -- borrowed from depositors or lenders.

Just as you would hope a car company sells cars for more than the cost of manufacturing them, you hope that a bank can lend out money at a higher interest rate than the interest rate it pays to borrow the money. That difference in interest rates, called the net interest margin (NIM), is analogous to an operating margin for an industrial company.

Let's look New York Community Bancorp (NYCB -1.19%) as an example. From its latest 10Q report, which covers the quarter ending September 30, 2016, New York Community Bank's total interest revenue is $416.1 million, and its total interest expense is $97.7 million, making its net interest income $318.4 million. To express that as a margin, it must be divided by the base and expressed as an annualized percentage.

The definition that Moody's uses for NIM is net interest income for the year as a percentage of average interest-earning assets. Net interest income is pretty straight forward -- we use the number from the last quarter (and we will adjust to calculate NIM as an annual percentage). Exactly what average interest-earning assets means can be slightly different for different analysts -- although the differences are generally not material.

Banks do financial reporting quarterly, so you could average the beginning and end of the quarter. The banks also disclose regulatory reporting numbers (call reports), which are done slightly differently. Some banks also disclose normalized numbers adjusting for non-taxable income -- if they get $1.00 tax free as interest on a municipal bond, that is equivalent to getting $1.54 in the 35% tax bracket. To be simple, let's use the numbers from New York Community Bank's latest quarterly 10Q report: 

Data source: New York Community Bank's latest quarterly 10Q report. Chart by author.

The sum off all of the securities, the cash, and the loans, net of allowances, is a reasonable approximation of their earning assets. That is $44,256.1 million. Dividing the $318.4 million by that, and multiplying by four (to annualize) results is a net interest margin of 2.9%.

This is about the same as the U.S. banking industry, as a whole. The chart below, using shows the evolution of NIM over time compared with the Fed Funds Rate.

 Source: Federal Bank of St. Louis.

This chart shows NIM for the U.S. banking industry as a whole from the beginning of 1992 until the middle of 2016. As is apparent, NIM is somewhat correlated with interest rates. I used the Fed Funds rate -- the chart looks about the same using Libor (London Interbank Offered Rate). Using quarterly data, I calculated a correlation coefficient of 0.55. That indicates that the aggregate NIM tenda to move with interest rates (the Fed Funds rate), but that the relationship is not close to exact. 

I would look at how the net interest margin compares with other banks in its peer group. Here you can see that net interest income varies between different types of banks. NYCB is a little low for its peer groups -- either New York institutions, or banks with $10 billion-$250 billion in assets.