Loan and deposit betas stabilize as rate cycle turns over

Increases in loan and deposit betas converged at the median bank in the US in the third quarter of 2023 as the industry looks for a bottom in net interest margins.

The cumulative deposit beta — or the change in deposit costs as a percentage of the change in underlying short-term rates since the Federal Reserve started lifting its target in early 2022 — hit 22.7% at the median during the third quarter of 2023, an increase of 4.4 percentage points from the prior quarter, according to S&P Global Market Intelligence data. The median loan beta increased nearly as much, climbing 4.1 percentage points to 17.4% in the same period.

Betas reflect the sensitivity of funding costs and asset yields to underlying rates and are a key determinant of net interest income (NII), banks' chief source of revenue. Increases in funding costs raced ahead of increases in asset yields in the first half of 2023, particularly in the first quarter, amid deposit outflows and a scramble by banks to defend liquidity.

Now, increases in both funding costs and asset yields are moderating as the Fed appears to have reached the end of its rate-hiking campaign.

"Net interest margins (NIM) and NII seem likely to trough in the near future, deposit flows are stable with pricing pressures now more contained," Piper Sandler analysts said in a Jan. 2 report.

Equalizing pressure

The Fed's rate increases came fast in the most recent cycle, with 125 basis points to 150 basis points of hikes quarterly from the second quarter of 2022 through the fourth quarter of that year.

The industry aggregate deposit beta was ahead of the mark reached over an equivalent time interval during the two previous rate-increasing cycles in the second quarter of 2023. The gap widened in the third quarter, with the current cycle's aggregate deposit beta at 38.5%, compared with 34.6% six quarters into the 2004-to-2007 cycle.

At 2.11% in the 2023 third quarter, the aggregate cost of deposits remained well below wholesale rates, with the effective fed funds rate averaging 5.26% during the period. As a result, deposit prices are likely to continue to increase even with the Fed on hold since July, and possibly through initial cuts.

Aggregate loan betas have also been higher this time than the previous two rate-increasing cycles, however, and analysts expect that asset yields will continue to reset upward.

"The bottom line is that NIIs [and] NIMs should trough in the next [quarter] or two as improving asset yields begin to offset funding cost pressures," the Piper Sandler analysts said.

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Looking for rate cuts

Betas vary widely across individual banks, reflecting differences in business models and loan and deposit concentrations.

Credit card specialists like Synchrony Financial and Discover Financial Services, which rely on online deposits, tend to have high deposit betas, along with high loan betas driven by their adjustable-rate credit card loans, for example. Industry aggregate betas are much higher than medians, reflecting the business mixes of large banks that make up large proportions of the aggregates.

With rate cuts in Fed projections and market expectations for 2024, banks like Citigroup Inc. and East West Bancorp Inc., which had highest deposit betas when rates were going up, will have more leverage to cut funding costs as the policy rate declines, BofA Global Research analysts said in a Jan. 4 report.

Broadly, the BofA analysts expect rate cuts to hurt NII, with assets initially repricing faster than deposits, like on the way up, before NIMs "stabilize as we near an end to rate cuts."

They expect the impact to be modest — a 1.2% to 1.4% median decrease to NII from 100 basis points of cuts — countered by positive impacts from rate cuts including higher asset values.