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Lagged deposit repricing continues to bite into bank margins

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Lagged deposit repricing continues to bite into bank margins

The Federal Reserve has initiated an easing phase, and some banks have declared that deposit costs have peaked.

But industrywide data shows that lagged repricing still has the power to crimp bank earnings, as deposit costs drift toward higher benchmark interest rates.

The cost of interest-bearing transaction accounts for U.S. banks increased 10 basis points from the previous quarter to 1.66% in the second quarter, according to S&P Global Market Intelligence data. That is larger than the previous 9-basis-point quarter-over-quarter increase.

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The Fed kept the range for its target overnight rate stable at 2.25% to 2.5% during the first half of the year before cutting it to 2% to 2.25% at the conclusion of its most recent policy meeting on July 31. Further cuts are widely expected, including at the next policy meeting in September.

In the aggregate, deposit rates are moving down, "but there are pockets of upward pressure," said Andrew Frisbie, an executive vice president at the advisory firm Novantas. "There's a lot of money on the commercial side that might be sitting at very low rates because it was only partially negotiated, and at some point" the client "might ask for more."

In recent periods, bank funding costs have also been pushed higher by a shift toward relatively high-cost certificates of deposit. Though time deposits represented just 16% of industrywide total deposits at the end of the second quarter, they accounted for 58% of growth in deposits since the end of 2017.

Overall, banks' cost of funds increased 3 basis points from the previous quarter to 0.97% in the second quarter.

While lagged repricing is generating a headwind, banks are primed to capitalize on Fed cuts quickly by lowering yields on deposits indexed to benchmark rates or that had been priced to parity with wholesale rates because of promotions and commercial customers that have negotiated assertively.

Yield curve inversion should also provide relief on CD costs because rates have plummeted on wholesale instruments of equivalent maturities to time-deposit products. Yields on six-month Treasurys have been below 2% since early August and 3-year Treasurys dipped below 1.5% in the middle of the month.

In a report in July, analysts at Piper Jaffray said their tally of deposit price changes across their bank coverage universe showed that decreases outnumbered increases in the second quarter, with reductions concentrated in CDs with maturities of 2 years to 5 years. In the year-ago quarter, increases outnumbered decreases by a factor of more than seven.

In fact, the deep sag across the medium-term section of the yield curve has already started to propel a shift away from CDs, according to Novantas. In a report after the Fed cut in July, the firm said its data showed a sharp decrease in the share of new consumer accounts represented by CDs from January to June.

Even as industrywide deposit growth had tilted toward CDs in recent periods, a number of large banks managed to buck the trend by building up their core checking account franchises.

From the second quarter of 2016 to the second quarter of 2019, the share of Bank of America NA's deposits held in transaction accounts increased 5.4 percentage points, while the shares represented by savings and time deposit accounts fell, according to S&P Global Market Intelligence data. Over the same period, the share of Citibank NA's deposits held in transaction accounts increased 6.7 percentage points.

But the banks that have demonstrated the greatest ability to control funding costs when rates were rising may have the least room to cut prices now.

"If the banks never really priced up a lot on the way up, there's simply not a lot of juice to price down on the way down," Frisbie said.