What it means
The idea is a cousin of the breakeven point in any business, applied to a balance sheet rather than to units sold. A bank's raw materials are deposits and borrowed money, its overheads are branches, staff and systems, and its revenue is interest and fees.
Breakeven yield expresses all of that as a single percentage of earning assets. Earning assets are the loans and investments that actually generate interest, which excludes premises, cash in the vault and other non-earning items.
Expressing costs against earning assets rather than total assets matters, because a lender with plenty of idle assets needs a higher yield from the productive ones. Getting that denominator wrong is the most common error in the calculation.
Fee income lowers the breakeven yield, which is why it matters so much to lenders. Arrangement fees, account charges and commissions cover part of the cost base, so the interest rate needed from the loan book falls.
A bank with strong fee income can price loans more cheaply than a competitor with the same cost of funds. The number is used as a pricing floor rather than a target.
A loan officer takes the breakeven yield, adds a margin for the expected credit loss on that type of borrower, then adds the required profit margin, and the sum is the minimum acceptable rate. Any deal priced below the floor needs a specific reason, such as a relationship that brings other income with it.
The term also appears in investing with a related meaning, where the breakeven yield on a bond or a foreign currency position is the return needed to offset costs or an expected currency move. In both uses the question is the same, which is what the position must earn before it earns anything at all.
Funding costs and market rates move constantly, so the figure has to be recalculated as conditions change.
In practice
Real-world examples.
Example
A credit union recalculates its breakeven yield after deposit rates rise and finds it has moved from 3.4% to 4.1%. It reprices new personal loans upwards by 70 basis points the same week, because loans written at the old rates no longer cover their funding cost.
Example
A motor finance company with heavy fee income works out a breakeven yield of 5.2% against a competitor's 6.0%. It uses the gap to win dealer business on headline rate while still clearing its own floor on every deal.
Example
A commercial lender reviews a proposal for a property developer priced slightly below the breakeven yield. The deal is approved only because the client also brings deposit balances and transaction fees that lift the whole relationship above the floor, and the exception is documented for the credit committee.
Formula
Calculation
Breakeven yield = (cost of funds + operating costs - fee income) / earning assets
A regional bank has $500,000,000 of earning assets. It pays $15,000,000 a year for deposits and wholesale funding, spends $7,500,000 running the business and collects $2,500,000 of fee income. The breakeven yield is (15,000,000 + 7,500,000 - 2,500,000) / 500,000,000 = 20,000,000 / 500,000,000 = 4%, so the loan book must average at least 4% before the bank earns anything. Adding an expected credit loss of 0.8% and a target profit margin of 1.2% gives a minimum lending rate of 4 + 0.8 + 1.2 = 6%, so a $2,000,000 loan priced at 5.5% falls 0.5% short of target, which is 2,000,000 x 0.005 = $10,000 a year of profit given away.Case study
Seen in the real world.
Stonefield Mutual Bank is an illustrative, fictional lender with $800,000,000 of earning assets whose profits had drifted down for three years while the loan book grew. Branch managers were competing on headline rate and each one believed their own deals were profitable.
The finance director calculated a single breakeven yield for the whole bank from funding costs of $28,000,000, operating costs of $14,000,000 and fee income of $6,000,000, giving (28,000,000 + 14,000,000 - 6,000,000) / 800,000,000 = 36,000,000 / 800,000,000 = 4.5%. A review of the previous year's new lending found that almost a fifth of it had been written below 5.3%, which was the floor once expected credit losses were added.
Stonefield put the breakeven yield on every pricing sheet and required written approval for anything below the floor. The illustrative outcome was slightly slower loan growth with a visibly better margin, which is usually what happens when a lender finally prices against its own cost base.
Watch out
Common mistakes.
- Dividing costs by total assets instead of earning assets, which understates the yield the productive part of the balance sheet actually has to deliver.
- Forgetting fee income, which overstates the breakeven yield and can push a lender into pricing itself out of perfectly good business.
- Treating the breakeven yield as the target rate rather than the floor, which leaves no room for credit losses or profit.
Questions
People also ask.
Is breakeven yield the same as net interest margin?
No, net interest margin reports the margin a lender actually achieved, while breakeven yield is the minimum it needed, so the gap between them is roughly where the profit sits.
How often should it be recalculated?
Whenever funding costs or the cost base move materially, which in practice means at least quarterly and immediately after any significant change in deposit pricing.
Does the idea apply outside banking?
Yes, any business that funds assets with borrowed money can calculate the return those assets must earn to cover funding and overheads, which is the same arithmetic under a different name.
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