Today, as the Fed increases rates for the ninth time this cycle, we move into a period of uncertainty for the first time in over a decade where the direction of the economy and potential Fed moves are not clear. Following the GFC, we had an unprecedented period of near-zero rates. And while rates have been slowly on the rise since 2015, the Fed has moved rates in a methodical and transparent way, leaving little variation around market expectations and no “surprise” moves (or non-moves).
Now, the S&P 500 is down for the year, the yield curve is inverted, the Fed relaxed language on future rate hikes, and rate decisions have taken a higher political profile. This uncertainty calls for greater rigor in scenario planning in order to fund the balance sheet. Banks need to plan for multiple potential rate scenarios — including continued rate rises, the dreaded “plateau”, and even potential decreases. Critical to this planning is understanding how various deposit pools (consumer, wealth, commercial) will grow or contract under each scenario, and how rates will move across key components of the portfolio (such as acquisition versus existing portfolio).
Consumer Deposits: Aggressive Pricing, but Divergent Strategies
In consumer, the inflection point we have highlighted since June 2018 continues to sharpen. The typical bank consumer portfolio beta (including the share of non-interest-bearing balances receiving zero interest) has been 11% from October 2015 through October 2018. But in the past year, from October 2017 to October 2018, the marginal beta has moved to 22% (see Figure 1).
In a world where 2019 may herald zero or one Fed increase, or even a Fed decrease, the optimal rate-based strategies change materially. Tactics like grandfathering products can be harder to implement in a falling rate environment; likewise, longer guarantees on promotional teaser rates have the potential to increase hedge costs should the Fed lower its future rate path.
On the other hand, the decline in checking balances, particularly from higher-balance accounts, that has taken place in 2018 (see Sidebar) has the potential to slow or reverse.
Executives need to be ready with proactive strategies at the retail level. As specific pools shrink (in part from a reversal of the shift to term), retail focus may need to move to other products. Likewise, the change in optimal tactics can have long lead times to implement. Tactics that are optimal given a continued rising rate path (12-month MMDA promotions, aggressive 18 to 24-month CD rates) may no longer look as attractive under a range of scenarios.
By Adam Stockton | Director, New York | firstname.lastname@example.org
and Andrew Frisbie | EVP, New York | email@example.com
In the low rate environment, growth in high-balance consumer checking accounts helped fuel growth in low-cost consumer deposit balances. According to Novantas’ Consumer Comparative Deposit Analytics spanning $2T+ in retail deposits, even in 2016 – 2017 consumer checking balances greater than $100K grew at 6.5% per year versus 2.5% in accounts less than $100K. (See Figure 2.)
In 2018 this trend has reversed. The larger-balance accounts now drive the decline in total balances, shrinking at 6.6% annualized through October, while the smaller-dollar accounts’ reversal has been less sharp, dropping to -5.5% annualized growth.
This unwelcome decline in consumer checking thus contributes to increasing marginal retail betas, as checking declines as a proportion of total retail balances. In response, bankers must plan their rate-based strategies with more care, seeking to minimize up-pricing in their rate sensitive book to offset this remixing.
Commercial Deposits: Uncertainty Even if the Fed Pauses
In commercial, the ongoing movement from lower-yielding to higher-yielding products (from DDA to IBDDA/MMDA/hybrid/sweep) and from standard-rate to exception-priced continues at a rapid pace, begging the question: will there be any customers not on exception pricing by the end of 2019?
A key uncertainty impacting the outlook for commercial balances is the potential for rate-paid to continue to increase for several quarters, even if the Fed pauses for an extended interval. This notion of the “creep of death” in rate-paid through momentum of product switching and competition among banks (and RMs) for low-cost funding may not diminish — particularly if the outlook for the commercial DDA and commercial non-operational funding pool growth is negative.
Small and Medium-Size Enterprise (SME) Deposits: Caught between Rival, Higher-Priced Regimes
The continued increases in rate-paid balances and marginal beta across consumer and commercial portfolios has made SME pricing an increasingly visible outlier, with lower rates paid on otherwise similar classes of deposits.
It is not unusual within one bank to see consumer MMDA promotional pricing above 200 basis points (bp), and commercial exception pricing at 175 bp or above for new deals or reactive pricing.
However, many SME MMDA balances are still held at rates less than 50 bp, creating the potential for increased channel conflict as SMEs try to force their way into more lucrative consumer structures (see Figure 3). Similarly, larger SMEs are pushing for exception pricing similar to the commercial segment, but without the volume, attractive lending balances, or fee-based products to support a hurdle-rate client ROE.
Given the uncertainty of the rate environment, each strategy should be evaluated relative to plausible interest rate (and macroeconomic) forecasts to understand the variability in possible outcomes. This “playbook” of potential strategies should then be updated on a regular basis (even quarterly), enabling management to proactively employ a strategy while having backups ready should the rate environment deviate from expectations.
Director, New York
Director, New York