Today, the FOMC announced its third cut on the overnight rate since July. While deposit bankers in consumer and commercial are racing to reprice their books, portfolio dynamics pose a challenge.
CONSUMER ACQUISITION COSTS ARE FALLING—BUT PORTFOLIO COSTS AREN’T
Retail liquid savings/MMDA product acquisition rates have moved down aggressively, according to data from Novantas Consumer Comparative Deposit Analytics, which includes roughly $2 trillion in retail deposits. The “strike price” for new money brought in, a blend of promotions and relationship money, declined to 1.16% in September from 1.42% in July. Portfolio rates, however, haven’t shown a commensurate decrease. In fact, they increased to 0.75% in September from 0.73% in July. The reason: ongoing churn from lower-cost savings products into promotional offers is pushing costs up even as the promotional rates themselves are decreasing.
The consumer CD picture is starker. Blended CD acquisition rates have matched declining forward rates since Q1 2019 (from a peak of 2.53% in February down to 2.11% by the July FOMC move and 1.77% in September), but portfolio rates have fallen just 0.02% since July. The term structure of CD portfolios stymies rapid repricing; CDs booked in early 2018 were priced at a discount to prevailing rates today, providing incremental upward pressure on renewals.
Novantas expects portfolio costs to remain stubborn. Promotional rates are falling, but with significantly lower than 100% downward betas, Money remixing will continue to be expensive and many banks have material balances on remaining 12-month or 3-month guarantees. Furthermore, portfolio churn levels remain elevated from 2017 despite signs of a modest decrease. As long as promotional rates remain above 1.50%, we expect churn to continue. Finally, there is very little room left to cut standard savings and back-book rates. These rates are already below 25 basis points (bp) and offer limited or no relief at most institutions. (See Figure 1.) Portfolio costs will eventually come down, but it will be a slow process for many.
WHILE MIX SHIFTS ARE TYPICAL, CD TERM STRUCTURES ARE UNUSUAL
As expected, declining rates are driving a shift in deposit mix. CD growth has been negative since July and liquid savings are enjoying a resurgence in growth.
While such mix shifts are typical of a falling-rate environment, CD term structure trends are decidedly not. Typically, the weighted average term of newly-booked CDs lengthens with lower rates (rate-sensitive customers shun the product and “CD diehards” often ladder the product to become a larger share of the smaller pie.) Over time, this reduces the typical portfolio term structure for most banks.
Due to the inverted yield curve, however, the average term of newly-booked CDs is shrinking. It stood at 12 months in September, down from 13 months in July and 16 months in March. (See Figure 2.) Importantly, Novantas data suggest that this trend is almost entirely supply-side driven; rate-sensitive customers and those who anticipate further rate decreases are looking for CD yield. But in many cases, banks are offering higher yields on short-term CDs than mid- and long-term CDs. If the yield curve normalizes, we expect the term trend to reverse based on analysis of historical data.
WHY DIRECT-BANK PRICING IS DIVERGING FROM BRANCH PLAYERS
As always, direct-bank pricing trends are instructive. Contrary to some expectations, direct banks have actually reduced CD acquisition rates by less than branch-based players. Direct banks have dropped CD acquisition rates by 20 bp (40% beta) since July, while standard players have dropped CD acquisition rates by 28 bp (56% beta). Direct banks, particularly larger ones, continue to have an incentive to price CDs aggressively for growth while harvesting margin from their large savings book, which is typically repriced as a single book instead of by tranche or sub-product.
Furthermore, while savings rates have decreased nearly across the board, downward betas are so far lower than upward betas. Over the final two Fed increases, an average of large direct-bank savings rates increased to a high of 2.15% (90% upward beta) from 1.70%. Over the first two decreases, however, rates have only fallen to 1.95% (60% downward beta) from 2.15%. The upshot is that competitive pressure for deposits remains strong in all sectors, slowing the hoped-for relief in interest expense.
WHAT TO DO NOW?
As bankers scramble to manage declining deposit costs (and pine for the original 2019 budget that counted on Fed Fund increases, not declines), customer-level analytics will be more important than ever. Broad-based rate declines are one key to success, but banks will beat plan by surgically targeting pockets of deposits where a higher downward beta is possible. Back-book portfolios, exception portfolios, promotional rates and terms are all key areas for exploration.
Banks must also prepare for the possibility that the rate environment stagnates. While margin relief is possible under a rising or falling scenario, stagnating rates would pose the challenge of continued high levels of churn and portfolio rates that are steady or rise further. Banks that come out ahead will have prepared for all eventualities, identifying strategies for cost-effective growth regardless of how the Fed acts going forward.
By Bob Warnock | Director, Chicago | firstname.lastname@example.org
Recent quarterly results in banks’ commercial and wealth lines of business suggest some interesting trends in response to recent Fed movements. These trends are surprisingly quite different from what we see in the retail segment.
Starting with commercial deposits, bifurcation of growth continues to be a clear theme. Regionals are underperforming the national players in terms of year-over-year growth, with the nationals experiencing an average of 3% compared with 1% for regionals. Additionally, anecdotal commentary suggests that pricing behaviors among banks towards clients is highly ad hoc and banks have already aggressively repriced relationships that benefited from high betas when rates were rising.
Within wealth, pricing is the more interesting trend. Brokerage and wealth sweeps have been very aggressive with their movements. Major players have moved cash balance tier rates aggressively lower, with betas ranging from 15% on the low end to 75% on the high end. Even more surprising is that some players are cutting rates multiple times during the same period of time in which the Fed has just cut rates once.
While all deposits will eventually reprice lower, the differences within wealth and commercial are stark relative to retail. Commercial has already moved on the easiest money to reprice, but increased analytics at the relationship level will be needed to avoid pricing mistakes. Finally, wealth-related deposits are already getting close to the bottom of what they will be able to push onto clients without elevated risk of attrition.