Bloomberg News this morning quotes me extensively on the squeeze on banks’ lending margins:

Feb. 10 (Bloomberg) — JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. are among lenders cutting back on $1.6 trillion of credit lines as they face increased demand for loans that threaten to drain capital.

Banks used loan negotiations with retailers Rite Aid Corp. and Ethan Allen Interiors Inc., and with homebuilder Ryland Group Inc. in the past month to reduce credit limits and raise interest rates. After more than $1 trillion of writedowns and credit losses, lenders are moving to lessen the chance that troubled companies will withdraw funds.

Cutting credit lines may free up capital that banks set aside to cover potential borrowing and allow them to make new loans. It also lowers the risk that struggling companies will take advantage of backup revolving lines of credit at rates agreed to before the credit crisis began in August 2007. General Motors Corp. and Ford Motor Co. led companies in drawing on at least $37 billion of the loans in the past year, according to Bloomberg data.

On Jan. 29, Dearborn, Michigan-based Ford borrowed $10.1 billion from a revolving credit line with an interest rate 2.25 percentage points above Libor — set yesterday at 1.23 percent. That compares with the 10.6 percent yield on the average high- risk, high-yield loan, according to Standard & Poor’s LCD.

Textron’s Line

Textron Inc., the maker of Cessna planes and Bell helicopters, drew down on $3 billion of credit lines last week because there wasn’t enough demand for its debt in the commercial-paper market, Doug Wilburne, vice president of investor relations, said at the Cowen & Co. Aerospace and Defense conference in New York on Feb. 5. He said the Providence, Rhode Island-based aircraft-maker is now paying 0.41 percentage point more than Libor, which amounts to $49.1 million annually on the loans.

At the same time, banks seeking to protect that amount of Textron’s debt from default using derivatives would pay an upfront fee of $855 million and $150 million annually, according to Credit Derivatives Research LLC in Walnut Creek, California.

Lower spreads on loans arranged before the credit crisis are limiting bank earnings, said David Goldman, the former head of fixed-income research at Bank of America and now a private investor. The net interest margin, which measures lending profitability, fell in 2008 to the lowest since records began in 1984, according to the Fed Bank of St. Louis.

In the recessions of 1991 and 2001, the margin climbed as the central bank cut its target lending rate, Fed data show.

No Relief

“For the banks, this is unlike all other recessions because it hasn’t shown any relief in terms of net interest margin,” Goldman said. “The poor performance of net interest margin, which is a critical measure of bank profitability, is a stern warning to the banks that they have to take a much more old-fashioned approach to lending.”

Companies paid an average of 8 to 10 basis points for access to untapped credit lines, Goldman said in an October report written for research firm Laffer Associates. A basis point is 0.01 percentage point.

“They gave away these revolving credit deals like party favors,” Goldman said. “They should be changing those deals. If banks have to lend money at their own cost of funds, we’ll never get out of this mess.”

Here is Net Interest Margin for all US banks as reported by the St. Louis Fed:

Pardon the poor quality of the graph — I am offsite with limited time to post (for complete data, follow the link to the St. Louis Fed page). The point is that NIM has been shrinking steady since the late 1990s. Why? Because banks used loans as a loss leader to get more profitable fee business. The foolish investor community thought that fee business was less cyclical than lending and rewarded bank equity performance for this ruse.

It’s time to go back to old-fashioned banking, if there are any banks left standing to do so.

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