Investors have been obsessed the last few years with asset quality and rightly so, as this has been the most important source of distress to the banking system. During normal times, however, the net interest margin that a bank receives is equally important in analyzing a bank. Net interest margin is defined as the interest income a bank receives less its interest expenses divided by it average earnings assets.

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An important part of this net interest margin is the cost of funding that a bank has, or what it costs it to keep and retain deposits and other liabilities on its balance sheet. There are many different components that determine this margin but, all things being equal, the lower your cost of funding the better.

Typically, banks with a high percentage of non-interest-bearing deposits will have a low cost of funds, while a bank with many brokered certificates of deposits will have a high cost of funding. Banks can make up for this high cost of funds by lending out at higher rates and preserving its margins, but this can be difficult to do in a competitive lending environment. It also raises the chance of making bad loans. Here are several institutions with cost of funds on the shockingly low side in the first quarter of 2009.

Four Banks With Low Cost of Funds
Westamerica Bancorp
(Nasdaq:WABC) is a commercial bank located in California with $5.6 billion in assets. The bank had one of the lowest costs of funding its balance sheet at 0.50% in the first quarter of 2009. The bank attributes this to its strong customer relationships that lead to higher core deposits, which are typically lower cost.

SVB Financial Group (Nasdaq:SIVB) is an interesting financial conglomerate with a banking subsidiary, an asset management businesses and a venture capital arm. The company's cost of funds was at 0.66%, based primarily on an extraordinary high amount of non-interest-bearing demand deposits on its balance sheet. (Learn more about the balance sheet in our article: Reading The Balance Sheet)

Cullen Frost Bankers Inc. (NYSE:CFR) had an average 0.61% cost of funds. The company had approximately 35% of its $11.458 billion in deposits in non-interest-bearing accounts. Cullen Frost turned down the offer of selling preferred stock to the U.S. Treasury last fall as part of the Capital Purchase Program (CPP).

Bank of Marin Bancorp (Nasdaq:BMRC) had a cost of funds of 0.66%. Approximately 25% of its deposits are non-interest-bearing and the bank has a limited reliance on time deposits. Bank of Marin received $28.2 million in CPP money but has since redeemed the preferred stock.

The Flip Side
One bank with a high cost of funds is Cathay General Bancorp (Nasdaq:CATY), with a cost of funds of 2.71% in the first quarter of 2009. The bank has about 10% of its deposits in non-interest-bearing demand accounts.

The Bottom Line
Once the recession and credit crisis passes and the extent of asset quality becomes more settled, investors will refocus on banks with strong net interest margins. It's just as important an indicator as asset quality. (Read Buy When There's Blood In The Streets, to learn how contrarian investors find value in the worst market conditions.)

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