Narrower loan margins may cut into the profits of three large U.S. regional banks even as they make more loans.

PNC Financial Services Group Inc
and US Bancorp -- the fifth and sixth largest U.S. banks -- beat analyst expectations by setting aside less money to cover bad loans for the quarter that ended on June 30.

But the results showed that interest margins, which are the returns on loans after paying deposit interest, are tightening.

The results highlight the difficulties regional banks face as they emerge from the credit crisis. On the positive side, loan losses are declining.

But loan demand is growing only slightly. And investor fears about the economy are pushing down longer-term bond yields, cutting into returns for lenders.

PNC's loan loss provision fell 66 percent to $280 million from $823 million a year ago. The decline contributed to the Pittsburgh-based bank's net income of $912 million, or $1.67 per share, up from $803 million, or $1.47 per share, a year ago.

Minneapolis-based US Bancorp reported net income of $1.2 billion, or 60 cents per share, up from $766 million, or 45 cents per share, a year earlier.

Also on Wednesday, regional lender M&T Bank Corp reported net income of $322 million, or $2.42 per share, up from $188 million, or $1.46 per share, a year ago.

Regional banks are not alone in coping with low rates. Northern Trust reported a 24 percent drop in net income, which the Chicago-based company blamed on lower interest rates.

TIGHTENING MARGINS

For many regional banks, growing loan books in the second quarter have not translated to similar increases in interest income.

At M&T Bank, loans rose 15 percent to $58.5 billion from $51 billion a year ago, helped by the acquisition of Wilmington Trust, but net interest income rose only 3 percent to $586 million from $482 million.

The slower increase was due in part to a decline in the interest margin to 3.75 percent from 3.84 percent.

At PNC and US Bancorp, margins were squeezed in the second quarter. PNC's interest margin fell to 3.39 percent from 4.35 percent a year earlier.

PNC Chief Financial Officer Richard Johnson said during a conference call with analysts that a decline in interest-bearing assets pushed the margin down, despite an increase in interest-free deposits.

The bank projects net interest income will remain stable for the rest of 2011, despite planning to have more loans on the books at the end of the year.

The bank earned $2.2 billion in interest income, down from $2.4 billion a year earlier.

Meanwhile, US Bancorp grew its total loans 4 percent during the quarter to $198 billion from $191 billion a year ago, but saw its own margin shrink to 3.67 percent from 3.9 percent.

The new loans helped push net interest income to $2.54 billion from $2.4 billion a year earlier.

(Reporting by Joe Rauch. Editing by Robert MacMillan)

(This story was corrected in paragraph 11 to say that M&T Bank's net interest income rose 3 percent to $586 million from $567 million, not $482 million)