The Fed cut the Federal Funds target rate today for the first time in more than a decade. Many banks now anticipate interest-expense relief, but are debating how much and how fast.
We see multiple trends that bankers must be aware of and plan for in response to this cut.
MOST OF CONSUMER MARKET MOVES DOWN, BUT TOP RATES LAG
Some sectors of the market have already reduced rates in anticipation of the Fed cut and due to the inverted yield curve. These reductions, however, haven’t been uniform across products, markets or banks.
The most notable change is an increased bifurcation between market average rates and the highest rates in market. Weighted Average Market Price (WAMP) has decreased in both consumer savings and CDs, down a modest 2-5 basis points (bp) for savings and a substantial 17-29 bp for 12-month CDs. (See Figure 1.) Maximum rates in each category have moved far less, however. There has been no change for savings and a decrease of just 10-16 bp for 12-month CDs.
In addition, some markets have moved more than others. WAMP for 12-month CDs varies from a high of more than 2.00% in Arizona to a low of less than 1.50% in Maine and Vermont, according to data from Informa. Some markets, notably in New England, have seen average rates drop more than 50 bp since first-quarter peaks, while other markets, notably in the Southeast, have seen decreases of less than 10 bp.
COMMERCIAL RATES MIXED IN JUNE
Commercial deposit rates were a mixed bag in June. Some banks started to selectively reduce interest-bearing deposit rates. In doing so, they targeted specific clients with clear justification, such as telling the client that rates are being cut because balances didn’t reach levels that had been promised.
These selective rate cuts may not have moved the needle on deposit costs at the portfolio level, however. Second-quarter earnings have shown some divergence in commercial-deposits costs, with most banks continuing to see upward pressure on rates. Some, however, saw early signs of relief. Still, the movements in either direction represent just a handful of basis points.
Early findings from the Q2 2019 Novantas Commercial Deposit Study show little movement in maximum and high-end exception rates, especially on interest checking and MMDA. Top rates continue to be in 240-275 bp range, fueled by continued competition for balances. This pressure will likely limit the reduction in these maximum rates despite our expectation that top rates will comes down with the Fed cut.
FALLING RATES POSE CONSUMER, COMMERCIAL CHALLENGES
The bifurcation of market rates illustrates a challenge for banks that are seeking deposit growth as rates fall. Acquiring new balances is typically most closely tied to top rates, so lead acquisition products will need to decrease less than average portfolio and standard rates. Even banks that are seeking interest-expense relief will need to make sure they don’t create deposit runoff by lowering entire deposit portfolios too quickly.
Our early projections indicate that downward commercial-rate betas for the most rate-sensitive products and clients (those closest to current max rates) may be in the range of 70% if banks want to retain balances while lowering deposit costs. On the retail side, many banks will be able to lower promotional rates with a 100% downward beta, but we expect to see continued bifurcation as banks that need higher growth will lag portions of their portfolio. Novantas models show overall portfolio betas may be in the 20-30% range for the first Fed rate cut, including maximum rates and standard rates.
MIX SHIFTS BACK TO LIQUID SAVINGS AS CHURN REMAINS ELEVATED, LED BY CONSUMER
Given the higher magnitude of rate decreases for consumer CDs compared with savings, consumers have begun to shift mix back towards liquid savings. While portfolio mix has not yet meaningfully changed, Novantas’ Comparative Deposit Analytics benchmarking shows a shift in acquisition. Some 26% of consumer acquisition went into CDs in June, down from 38% in January. We expect to see acquisition mix continue shifting back towards savings as the rate gap between savings and CDs shrinks.
We also anticipate churn rates to remain high across consumer deposits even as some rates decrease. Attrition and switch levels are already elevated, with no change in churn metrics since December 2018. Given the trends both on the most recent upcycle and the previous downcycle, we expect churn levels to remain elevated while promotional rates remain above 1.50%, likely through three or four Fed cuts.
Our expectation is that commercial will follow suit if, and when, declining rates are paired with troublesome macroeconomic indicators or continued global trading concerns. With a singular “re-set” rate move, we expect little change in commercial. If we enter a steadier declining-rate environment due to a weakening economy, commercial deposits would likely shift to more liquid products.
LOW BACK-BOOK RATES AND MIX SHIFT LIMIT INTEREST EXPENSE RELIEF
Commercial deposit mix continues to shift away from non-interest-bearing products like ECR DDA and into interest-bearing products like interest checking. Deposits are also shifting from lower-interest-bearing products to higher-interest-bearing products. This trend continued to be strong in the first quarter of 2019, and early indications show a similar trend in the second quarter. Non-interest-bearing commercial deposits are decreasing and growth in interest-bearing deposits is driving any net growth.
In consumer, one of the most significant differences between the current environment and last falling-rate environment in 2007-2008 is the level of ‘back book,’ or standard rates. From Novantas’ Comparative Deposit Analytics benchmarking, standard consumer savings rates averaged 0.92% in 2007 compared with 0.10% today. Standard non-money market (non-promotional) consumer rates averaged 2.37% compared with 0.81% today.
The current low levels of standard rates means that downward betas will be under 100% on these portfolios. More than half of retail savings and money market deposits are under 25 bp and only 35% of commercial deposits receive standard rates. (See Figure 2.) Banks would need to lower front book and promotional/acquisition rates by more than 25 bp to achieve a full 100% downward beta.
In other words, the muted upward betas that banks enjoyed on back-book portfolios also need to set expectations for forecasting rates on the down cycle. Almost no banks will achieve a full 100% downward beta on the way down.
KEY TAKEWAYS FROM THIS RATE CUT
Banks that slash rates across the board after this Fed move will open themselves up to meaningful risk. Instead, banks should keep close watch on balance trends. Yes, there is a rate decrease, but we have not yet observed corresponding drop in loan demand or increase in deposit supply. So while rates can come down, it’s still a hot deposit market. In short, lower rates with caution.
Relationship pricing at the client and customer levels is more important than ever in this new environment, allowing banks to surgically trim prices without cutting into the bone of balances at risk.
Banks should also consider opportunities to segment portfolios. Customer segments that are less price-elastic may tolerate a 100% beta, while more elastic segments may require a beta of 60% or less to maintain current balance levels. This can help banks mitigate much of the latent risk across both retail and commercial, while still allowing for meaningful expense relief.
In addition to monitoring your own portfolio, keep abreast of industry trends. Any move to reduce top-line rates below competitors will hurt customer acquisition, so don’t be surprised at the reaction if that is the strategy you pursue. There are many opportunities to curtail rates, but they require careful analysis and cautious action, especially relative to others.
Finally, exercise extreme caution with upcoming scheduled decisions about retail CD maturities and top-of-market commercial deposits. CD maturity bubbles are comprised of sticky money and transitory money. Profit-taking opportunities exist, but must be managed on underlying behavioral characteristics.
Director, New York