A Statistical Analysis of the Factors Affecting

S&Ls’ Net Interest Margins

Office of Thrift Supervision

Risk Management Division

_________________________

Anthony G. Cornyn, CFA

Director

Donald Edwards

Radu Filimon, Ph.D.

Eberhard Irmler

Robert Kazdin

Elizabeth Mays, Ph.D.

_________________________

Office of Thrift Supervision

1700 G Street, N.W.

Washington, D.C. 20552

Introduction and

Summary

After an extended period of

declining interest rates in the

early 1990s, rates began to

i n c rease in February 1994. By

year end, the one-year Treasury

yield had increased more than

350 basis points and the ten-year

Treasury yield had incre a s e d

nearly 200 basis points.

Because most S&Ls have asset

durations that are greater than

their liability durations, their

income is typically expected to

decline when interest rates

increase. What we observed during the 1994 rate run-up, however, was that net interest margin

(NIM) for the industry as a

whole remained relatively stable

c o m p a red to its 1993 level.

During 1994, the NIM of the

median institution declined only

7 basis points and NIM actually

increased for 41 percent of institutions.

In this Risk Management Release

we examine the factors that contributed to changes in NIM, both

negative and positive, during

1994. Our analysis indicates that

although interest rate exposure

contributed to a decline in NIM

for many institutions, there were

a number of other factors that

had a significant positive effect

on NIMs and resulted in the relative stability of NIM for the

industry as a whole. The most

important of these factors were:

• The ability of institutions to

retain nonmaturity deposits as

rates rose even though increases in the offered rates on their

deposits lagged behind

increases in market rates.1

• A shift toward assets with

higher credit risk, and presumably higher yields. A number

of institutions also incre a s e d

their relative holdings of fixedrate mortgages (FRMs). FRMs

typically have higher coupons

than adjustable-rate mortgages

(ARMs) but increase most

S&Ls’ interest rate exposure.

• An increase in interest-earning

assets relative to interest-bearing liabilities.

• The rolloff of older, high-rate

CDs issued in the early 1990s.

In the next section, we examine

how interest income and interest

expense for the thrift industry

changed in 1994 relative to 1993.

In Section III, we describe in

m o re detail the factors that

significantly affected the change

in NIM.

Risk Management Series

By Elizabeth Mays, Ph.D., Senior Financial Economist

(202)906-5729

1 Nonmaturity deposits include transactions accounts, MMDAs, and passbook

accounts.
Office of Thrift Supervision

page 2

Changes in Interest

Income and Expense

in 1994

When interest rates increase, we

expect thrift interest income and

interest expense to increase. For

thrifts whose asset duration is

longer than that of liabilities, we

expect interest expense to

i n c rease faster than intere s t

income, resulting in a decline in

net interest income. The opposite

would be true for thrifts with a

longer liability duration than

asset duration. That is, income

should increase faster than

expense, resulting in an increase

in net interest income.

Surprisingly, instead of interest

income and interest expense

both increasing in 1994, interest

income, as a percent of assets,

declined for 53 perc e n t

(684/1294) of institutions analyzed, and interest expense fell

for 42 percent (547/1294) of institutions (see Table 1).2

Median NIM for the industry

declined only 7 basis points during 1994 as interest rates rose

significantly. The cause of this

modest decline was unexpected.

While median interest expense

i n c reased by 4 basis points,

median interest income unexpectedly declined 2 basis points.

Of the 534 institutions with an

i n c reased NIM in 1994, more

institutions actually saw interest

expense decline (332 thrifts) than

increase (202 thrifts). For these

institutions, the median increase

in NIM was 21 basis points, with

median interest income increasing 19 basis points, and median

interest expense declining 4 basis

points.

Of the 760 institutions with a

decline in NIM, only 215 experienced declining interest expense.

The median decrease in NIM

was 27 basis points, with median

i n t e rest income decreasing 17

basis points, and median interest

expense increasing 10 basis

points.

The large number of institutions

experiencing declining intere s t

income and expense as market

rates increased in 1994, suggests

t h e re were other factors that

accounted for the changes in

NIMs. In the next section we

describe those factors.

Factors Affecting

Changes in NIM

To determine what factors

influenced changes in NIMs, we

performed a cro s s - s e c t i o n a l

regression analysis using as the

dependent variable the average

NIM in 1994 minus the average

NIM in 1993 for each institution.

The factors that had a significant

influence on NIM are discussed

in this section. The first three factors have an inverse relationship

to NIM. That is, the higher their

value, the bigger the decline (or

smaller the increase) in NIM. The

remaining seven factors have a

positive relationship to NIM.

Table 2 provides statistics on

each variable for the group of

534 institutions for which NIM

increased in 1994, and the 760

institutions for which NIM

2 The data set for this study consisted of 1,294 institutions for which OTS NPV Model Exposure Report results were available for

all eight quarters of the 1993 through 1994 period.

Table 1. Direction of Change in Interest Income and

Expense in 1994 Relative to 1993

(Number of Institutions in Each Category)

Interest Income/Assets

Interest Expense/ Increased Decreased Total

Assets

(All Thrifts)

Increased 378 369 747

Decreased 232 315 547

Total 610 684 1294

(Thrifts w/Increased NIM)

Increased 202 0 202

Decreased 232 100 332

Total 434 100 534

(Thrifts w/Decreased NIM)

Increased 176 369 545

Decreased 0 215 215

Total 176 584 760
Risk Management Series

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d e c reased. The value of each

variable is listed at the 10th, 50th,

and 90th percentiles for each

income gro u p .3 All variables

that re p resent the change in

some financial ratio (such as the

change in the ratio of nonmaturity deposits to liabilities) are calculated as the average ratio in

1994 less the average ratio in

1993, and thus are positive if that

ratio increased.

duration, the more its net portfolio value (NPV) is expected to

decline in a rising rate environment. For most S&Ls, the duration of assets is greater than that

of liabilities. The median asset

duration for the industry was

estimated by the OTS Net

Portfolio Value Model to be 1.78

percent as of March 1994, while

that of liabilities was 1.61 percent.5

Variable 1 is the duration of

assets as of March 1994 minus

that of liabilities, or the “duration mismatch.” The median

duration mismatch for the industry is 0.15, but ranges from a high

of 2.89 percent to a low of -2.84

p e rcent. The median duration

mismatch is 0.04 for institutions

for which NIM increased in 1994

but is much higher, 0.34, for

institutions for which NIM

declined (see Table 2).

The negative re g re s s i o n

coefficient indicates that institutions with larger mismatches

experienced greater declines in

NIM (or smaller increases) during 1994. Along with changes in

credit risk and changes in the

amount of nonmaturity deposits,

this variable is one of the three

most important factors explaining changes in NIM during this

period.

Table 3 lists the results of the

regression analysis including the

regression coefficients, the standardized regression coefficients,

and the significance level of the

associated t-statistics.4

Duration Mismatch (Variable 1)

The more an institution’s asset

duration exceeds its liability

3 The 50th percentile, also known as the median, is the value in the middle of a set of numbers that have been ranked from high

to low. Similarly, the 90th percentile is the number that is greater than 90 percent of the other numbers in the set.

4 Standardized regression coefficients can be used to evaluate the relative importance of the independent variables in explaining

the variation in the dependent variable. They indicate by how many standard deviations the dependent variables is expected

to change as a result of a one standard deviation change in the independent variable. Variables with large standardized regression coefficients can be said to have had a greater influence on changes in NIM than those with small ones.

t-statistics are used to test if the coefficient estimates are significantly different from zero; that is, if there really is a relationship

between the dependent and independent variable. Generally, if the significance level is .1 or less, researchers will accept the

hypothesis that such a relationship exists.

5 The OTS NPV Model produces estimates of the market value of several categories of assets, liabilities, and off-balance sheet

contracts under a range of interest rate scenarios. The effective duration of each category of assets and liabilities is estimated

by calculating the percent change in value that results from a 100 basis point shock.

Table 2. Financial Measures by Income Group

Measures for Thrifts with

Rising NIM Falling NIM

10th 50th 90th 10th 50th 90th

Change in NIM (basis points) 3 22 59 -5 -27 -66

1. Duration Mismatch -.62 .04 .95 -.40 .34 1.19

2. % Liabs Repricing During 1994 23.2 36.4 53.5 24.3 37.7 55.6

3. Change in Ratio of Nonaccrual -.93 -.08 .22 -.62 -.07 .28

Assets to Total Assets

4. WAC on Repricing CDs 2.77 3.19 3.72 2.74 3.19 3.62

5. Nonmaturity Deposits as % of 18.8 33.4 54.1 18.0 31.8 51.3

Liabilities

6. Change in Ratio of Nonmaturity -5.0 -1.3 1.6 -6.9 -2.5 .68

Deposits to Total Liabilities

7. Change in Ratio of FRMs to Assets -5.9 -.08 6.2 -7.5 -1.3 4.5

8. Change in Risk-Based Capital Ratio -.18 .08 .41 -.28 .01 .29 

9. Change in WAC on Teaser ARMs -18 0 63 -39 0 54

(basis points)

10. Change in Ratio of Interest Earning -.6 1.4 4.2 -1.7 .8 3.0

Assets to Interest Bearing Liabilities
ties repricing during 1994 was

not dramatically diff e re n t

between institutions with

increasing and decreasing NIM.

As Table 2 shows, institutions for

which NIM declined in 1994 had

a larger percentage of liabilities

scheduled for repricing in the

next year (median of 37.7 percent) than institutions for which

NIM increased (median of 36.4

percent). The difference is somewhat greater at the 90th percentiles (55.6 versus 53.5).

Change in Ratio of Nonaccrual

Assets to Total Assets

(Variable 3)

If nonaccrual assets relative to

total assets decline, we would

expect to see interest income,

and NIM increase. The numbers

in Table 2 show that institutions

for which NIM increased during

1994 experienced larger declines

or smaller increases in nonaccrual assets than institutions for

which NIM decreased. The

re g ression results confirm the

influence of nonaccrual assets on

NIM during this period.

Weighted Average Coupon on

Repricing CDs (Variable 4)

Surprisingly, the rates paid on

CDs by some institutions actually declined during 1994 even

though market rates increased. A

number of institutions had older,

high-rate CDs, that matured during 1994 and reset to significantly lower rates. The median rate

on new CDs issued by thrifts in

March 1990, with maturities of

three years or more, was 8.1%.

Office of Thrift Supervision

page 4

liability duration of 0.5. Because

the second institution has a larger percent of liabilities repricing

in the near future, it will experience a decline in NIM sooner

than the other institution in a rising rate environment, even

though their losses over the

remaining life of the portfolio

would be very similar.

The re g ression results indicate

that institutions with a larg e r

percent of liabilities scheduled

for repricing during 1994 experienced greater declines (or small

increases) in NIM. This variable,

however, was not a very important one in explaining changes in

NIM. Statistically, the relationship was barely significant.

Moreover, the percent of liabiliPercent of Liabilities Repricing

During 1994 (Variable 2)

The duration mismatch tells us

the expected direction of change

in NPV and long-term NII.6 It

does not necessarily indicate

how NII will change in the nearterm. Two institutions with the

same duration mismatch could

experience substantially diff e rent changes in their short-term

NII depending on when their liabilities reprice.

For example, two institutions

could both have a duration mismatch of 1.0, but very different

asset and liability durations. Say

one institutions has an asset

duration of 2.5 and a liability

duration of 1.5, while the other

has an asset duration of 1.5 and a

6 For more information on this topic, see “NII and NPV Simulation: Are the Two Methods for Measuring IRR Consistent?” by

Elizabeth Mays, published by OTS in August 1995. 

Table 3. Regression Results

Standardized

Regression Regression Significance

Coefficient Coefficient Level

Intercept -26.24 0.0 .0067

1. Duration Mismatch -13.26 -.222 .0001

2. % Liabs Repricing During 1994 -.193 -.057 .0810

3. Change in Ratio of Nonaccrual -5.68 -.084 .0008

Assets to Total Assets

4. WAC on Repricing CDs .078 .075 .0035

5. Nonmaturity Deposits as % of .199 .066 .0405

Liabilities

6. Change in Ratio of Nonmaturity 2.60 .230 .0001

Deposits to Total Liabilities

7. Change in Ratio of FRMs to Assets 1.18 .162 .0001

8. Change in Risk-Based Capital Ratio 31.24 .222 .0001 

9. Change in WAC on Teaser ARMs .072 .098 .0001

(basis points)

10. Change in Ratio of Interest Earning 1.61 .144 .0001

Assets to Interest Bearing Liabilities
Risk Management Series

page 5

Rates declined substantially in

the early 1990s before beginning

to once again trend upward in

1994. Despite the rate run-up, the

median rate on newly issued

three-year CDs was significantly

lower, at 6.80%, than in the early

1990s.

The higher the weighted average

coupon (WAC) on CDs scheduled to reprice during 1994, the

less interest expense would

increase (and thus, NIM decline)

when rates rise. The WAC on

CDs scheduled for repricing during 1994 is higher at the 90th percentile for the group for which

NIM increased (3.72%) than the

group for which NIM decreased

(3.62%). Thus, it appears there

was a small, but significant

group of institutions for which

NIM was bolstered by the repricing of older, high-rate CDs. This

is confirmed by a positive and

significant regression coefficient.

Nonmaturity Deposits as

Percent of Liabilities

(Variable 5)

In general, thrifts were slow to

raise offered rates on nonmaturity deposits in 1994 even though

short-term Treasury yields

increased by more than 300 basis

points between December 1993

and December 1994.7 Figure 1

c o m p a res the median rate

offered by S&Ls on interest-bearing transactions accounts,

MMDAs, and passbook accounts

to the 3-month Treasury yield.

As Treasury rates rose during

1994, there was only a minimal

increase in the median offered

rates on passbook accounts (10

basis points) and MMDAs (24

basis points), and no change in

the median offered rate on interest-bearing checking accounts.

Because institutions were able to

hold down offered rates, an institution with a large volume of

nonmaturity deposits would be

expected to show a smaller

increase in interest expense, and

as a result, a smaller decline, or

even an increase in NIM. Indeed,

institutions for which NIM

increased in 1994 generally had

more nonmaturity deposits as a

percent of liabilities (median of

33.4 percent) than institutions for

which NIM decreased (median

of 31.8 percent). The regression

results indicate that large holdings of nonmaturity deposits

was a significant factor explaining increases in NIM during

1994.

7 Rates on retail CDs, on the other hand, increased by at least as much as Treasury yields. The median rate offered by thrifts on

new CDs with maturities between six months and one year increased from 3.55% to 6.15% (258bp), exceeding the 228 bp

increase in the 6-month bill rate during that period. Similarly, the median rate on new CDs with maturities between one and

two years increased from 4.06% to 6.40% (234bp), exceeding the 205bp increase in the 1-year bill rate.

Figure 1. Quarter-end Median Interest Rates on S&Ls’

Nonmaturity Deposits and on 3-month T-bills

200

300

400

500

600

700

800

900

1000

1100

Checking

Passbooks

MMDAs

T-Bills
Office of Thrift Supervision

page 6

On average, a 1.0 perc e n t

increase in the FRMs’ share of

total assets would increase institutions’ NIMs by 1.2 basis points

during this period.

Change in Risk-Based Capital

Ratio (Variable 8)

In the same manner that an institution may increase interest rate

risk to attain higher yields, so too

may an institution take on additional credit risk. To determine

whether this was a significant

factor in 1994, we used riskbased capital requirements as a

proxy for credit risk.

The capital re q u i re m e n t

increased for 67 percent of institutions for which NIM increased

while it rose for only 53 percent

of institutions in the other group.

At the 90th percentile, the capital

re q u i rement as a percent of

assets increased 0.41 basis points

for the first group, but only 0.29

basis point for the other group.

The re g ression results indicate

this shift toward assets with

greater credit risk was one of the

most significant factors contributing to rising NIMs.10

Change in Ratio of Nonmaturity

Deposits to Total Liabilities

(Variable 6)

When offered rates on deposits

lag increases in market rates,

t h e re is an incentive for customers to withdrawal their

deposits. The numbers in Table 2

show there was some loss of

nonmaturity deposits during

1994 for both income groups at

the median. Institutions with

declining NIM had a larg e r

decline in nonmaturity deposits

(decline of 2.5 percent of liabilities at the median) than institution with increasing NIM

(decline of 1.3 percent of liabilities).

The re g ression results show a

positive relationship between

the change in nonmaturity

deposits and the change NIM in

1994.8 That is, institutions with

declines in the ratio of nonmaturity deposits to liabilities experienced larger declines in NIM. On

average, a 1.0 percent decline in

the ratio of nonmaturity deposits

to total liabilities produced a

drop of 2.6 basis points in institutions’ NIMs during this period.

Change in Ratio of FRMs to

Assets (Variable 7)

In periods of rising rates and

declining interest margins, institutions may be tempted to invest

in assets with higher yields (and

greater risk). In the case of mortgages, for example, this may

involve a switch fro m

adjustable-rate mortgages to

fixed-rate mortgages. Such a

switch would also increase the

interest rate risk of most institutions.9

Although the median institution

in both income groups decreased

their holdings of FRMs as a percent of assets in 1994 relative to

1993, the holdings of FRMs

increased for 49 percent of institutions for which NIM increased,

but for only 36 percent of institutions for which NIM declined. At

the 90th percentile, the change in

FRMs as a percent of assets was

notably larger for institutions for

which NIM increased (increase

of 6.2 percent) than for the other

group (increase of 4.5 percent).

The re g ression results confirm

that an increase in FRMs was a

significant factor leading to

increases in NIM during 1994.

8 There were 266 institutions that increased their holdings of nonmaturity deposits as a percent of total liabilities in 1994. The

increases were fairly small, however, with only 5 percent of the institutions increasing nonmaturity deposits by more than 5

percent of liabilities. Sixty percent of the 266 institutions increased offered rates on core deposits at least slightly, but only ten

percent of them increased rates by more than 65 basis points. Thus, some institutions appear to have been able to attract new

nonmaturity deposits by increasing offered rates but by less than they would have had to for other types of funds.

9 Ideally, one would include the change in measured interest rate risk as an independent variable in the regression to determine

if the institution took some action to increase yield at the expense of increased risk. Because duration changes with the level of

interest rates, however, changes in measured IRR include both changes in interest rate exposure that result from actions of institutions as well as those that occur as a result of changing market rates.

10 Analysis of the change in the asset composition of the two income groups indicated that institutions with increasing NIMs had

a larger increase in construction loans, commercial loans, and consumer loans than the other income group.
Risk Management Series

page 7

First, institutions were able to

hold down interest rates on nonmaturity deposits with only

moderate deposit run-off. It is

likely that the pace of run-off

would have accelerated during

1995 if the large spread between

deposit offered rates and market

rates had persisted. As it happened, market rates declined

throughout most of 1995, and

nonmaturity deposit levels stabilized.11

Second, institutions appear to

have increased income by shifting into assets with greater credit risk and interest rate risk. The

i n c rease in risk-based capital

re q u i rements during 1994 and

the increase in fixed-rate mortgages as a percent of assets are

examples of such shifts.

Other factors that helped to bolster NIM include an increase in

the ratio of intere s t - e a r n i n g

assets to interest costing liabilities, and a decline in intere s t

expense for a number of thrifts

whose older high-rate CDs

rolled over to lower market rates

■

Change in WAC on Teaser

ARMs (Variable 9)

Many institutions lowered the

initial coupon (”teaser rate”) on

ARMs in 1994 compared to 1993.

In fact, the reported weighted

average coupon (WAC) on teaser

ARMs fell for 224 out of 560

institutions reporting teaser

ARM balances even as interest

rates increased. This would

result in lower net income in

1994, all else equal. The percentile measures show that institutions for which NIM declined

showed larger decreases or

smaller increases in the WAC on

teaser ARMs than those for

which NIM increased. The

re g ression results confirm that

an increase in ARM teaser rates

was a significant factor contributing to increases in NIM.

Change in Ratio of Interest

Earning Assets to Interest

Bearing Liabilities (Variable 10)

An increase in the amount of

i n t e rest-earning assets re l a t i v e

to interest-bearing liabilities

should, of course, lead to a larger NIM. This could result from a

d e c rease in non-interest bearing

assets such as from the liquidation of REO, or an increase in

equity capital. The median

i n c rease in this ratio in 1994 re lative to 1993 for the industry

was one percent. Institutions for

which NIM increased showed

l a rger increases in this ratio (or

smaller declines) than institutions for which NIM decre a s e d .

The re g ression results confirmed

the significance of this variable

in explaining changes in NIM

during 1994.

Conclusion

NIM for the thrift industry

remained relatively stable during 1994 even as interest rates

rose. Rising rates generally had a

negative effect on the NIMs of

S&Ls as a result of their

assets/liability mismatches.

There were a number of other

factors, however, that contributed positively to net interest

income. The result was fairly stable NIMs for the industry during

this period.

11 The industry average ratio of nonmaturity deposits to total liabilities was 32 percent in June 1994 and declined to 28 percent at

year-end. It declined further, to 26.7 percent, at March 1995 then leveled off at about 25 to 26 percent in the remaining quarters

of 1995.