Loan and deposit betas diverge as banks look for bottom in margins

Delayed rate cuts have pushed out hopes for lower deposit costs, and data from the fourth quarter of 2023 showed the potential for asset yield and liability cost shifts to disappoint.

The cumulative deposit beta was 26.7% at the median US bank during the final three months of 2023, S&P Global Market Intelligence data shows, 4.0 percentage points higher than in the previous quarter. The figure reflects an ongoing slowdown in cumulative deposit beta increases as the Federal Reserve's last rate cut moves further into history and deposit cost increases taper overall.

Relative to the deposit beta, the cumulative loan beta lost ground, increasing just 3.2 percentage points from the previous quarter to a median 20.6% and helping to drive the median net interest margin down further. Changes in median cumulative deposit and loan betas came close to equalizing in the third quarter of 2023.

Analysts still anticipate a continued tailwind as asset yields climb. Banks have started to take steps to change deposit strategies in anticipation of lower rates, and slower and fewer rate cuts could be positive for much of the industry overall.

"Our forecasts continue to incorporate a recovery in [net interest income in the second half of] 2024 and 2025 for most banks as deposit cost pressures ease and fixed rate assets re-price at higher yields," HSBC Global Research analyst Saul Martinez said in a March 27 note previewing upcoming bank earnings reports. "We think it is worth noting that a macroeconomic backdrop in the coming years characterized by positive real interest rates ... some term premium on longer dated government securities, and nominal GDP growth of [about] 4-5% is favorable for bank profitability."

Down betas

Aggregate cumulative loan and deposit betas in the current cycle have exceeded cumulative betas at the same point in the previous two tightening cycles for several quarters. The current cycle was characterized by rapid and sharp rate hikes early on by the Fed.

Attention has now shifted to what betas might look like once the Fed starts cutting rates. Some analysts anticipate a gradual reaction in overall deposit costs.

"The industry seems to have digested a rate outlook with fewer cuts, as the highest offerings hover around the Fed funds rate (5.25%-5.50%), but [banks] are prepared to react to the first cut," Jefferies analysts said in a March 21 report that tracks advertised rates. Nevertheless, "deposit costs may still see a slow descent if this rate trajectory comes to fruition."

Broadly, with industrywide savings balances yielding 1.8% in the fourth quarter of 2023, banks are paying considerably less for funding than wholesale rates and would be even after a few cuts.

"The first rate cut or two will likely have a more measured impact on deposit costs," Piper Sandler analyst Casey Whitman said in a note on March 25, though "this can be very dependent on an institution's balance sheet makeup and competitive forces within a given deposit market."

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Relative positioning

Factors that influence beta performance among individual banks, such as exposure to variable-rate loans, or to wealth management and corporate deposits, which tend to re-price quickly, can be stable across cycles.

Banks with the highest, or worst, cumulative deposit betas in the current cycle also tend to have had high deposit betas during the most recent easing cycle, when the sensitivity helped drive down funding costs. The median for the group was 61.5% during the easing cycle from the second quarter of 2019 through the fourth quarter of 2021, compared with an industrywide median of 23.4%, according to S&P Global Market Intelligence data.

The same relationship generally holds for banks with the lowest deposit betas, and the highest and lowest loan betas.

After a strong run in Wells Fargo & Co.'s shares, Keefe Bruyette & Woods analyst David Konrad downgraded the bank, a move that reflects anticipated payback from deposit costs that did not rise as much as competitors' when the Fed was hiking.

Wells Fargo said its performance was helped by an asset cap imposed by regulators that forced it to turn away some rate-sensitive deposits.

Wells Fargo's net interest income is now likely to underperform peers, Konrad said in a March 26 note. "Not only is their balance sheet asset sensitive, the asset cap forced [Wells Fargo] to be more geared toward consumer deposits, which were more sticky on pricing in higher rates but will also likely be sticky in declining rates."