Regional Banks: The Advantaged Deposit Franchise of WFC

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September 27, 2013

Regional Banks: The Advantaged Deposit Franchise of WFC

  • Unlike other regional banks we cover, changes in the net interest margin at WFC are almost entirely explained by the loan/deposit ratio (see Exhibit). At other regional banks, this ratio has explained less than 30% of margin variation over the last 10 years.
  • Our interpretation is that other banks have used pricing more aggressively to regulate the balance sheet (by, for example, lowering the rate paid on deposits to staunch deposit flows) while WFC has used pricing less aggressively and more readily accepted the margin compression associated with a declining loan/deposit ratio (also affected by the run-off of legacy real estate portfolios).
  • Even so, over the last 3 years, WFC’s deposit rates have been the lowest of the regional banks we cover and deposit growth among the highest. We view this as an indication of an advantaged deposit franchise and relatively rate-insensitive deposit customers.
  • This relative rate insensitivity will be important as the yield curve renormalizes, and we expect WFC’s net interest margin to expand more than other regional banks as a result.

Exhibit: Net Interest Margin versus Loan/Deposit Ratio for WFC over last 10 years


There are meaningful differences between the deposit behavior of WFC and other regional banks. Over the last 10 years, the loan/deposit ratio at WFC has explained substantially all of the variation in the net interest margin with the relationship being particularly striking since the financial crisis (see Exhibit 1).

Exhibit 1: Net Interest Margin versus Loan/Deposit Ratio for WFC

This may not seem like a surprising result given a common-sense interpretation that excess liquidity is invested in securities (through AFS portfolios, for example) which tend to be less profitable than loans, so that the net interest margin declines. However, the surprise is that this relationship does not hold for other regional banks; for example, there is no meaningful relationship in the case of BBT (see Exhibit 2).

Exhibit 2: Net Interest Margin versus Loan/Deposit Ratio for BBT

In fact, WFC is an outlier in that the relationship between its net interest margin and loan/deposit ratio is unusually strong. For WFC, the loan/deposit ratio accounts for 94% of the variation in the net interest margin over the last 10 years while this statistic is below 30% for all other regional banks in our sample except STI where it is 40% (see Exhibit 3).

Exhibit 3: R-squared Statistic for Relationship between Loan/Deposit Ratio and Net Interest Margin over Last 10 years

We believe the explanation for these differences lies in bank pricing policy. Most banks tend to use pricing to regulate their balance sheets so that if there are excess deposit flows, they reduce the rate paid and if there are insufficient loan flows they reduce the rate asked (and/or otherwise loosen terms). KEY, for example, has a target range for it loan/deposit ratio and, if it kept strictly to the range, variations in the supply/demand balance for deposits/loans would show up in margin changes while the loan/deposit ratio stayed within the target range; as a result, the relationship between margin changes and the loan/deposit ratio would be weak.

In practice, KEY’s balance sheet target has been overwhelmed by excess liquidity so that he loan/deposit ratio at 84% is below the 90% minimum of the target range. The bank has apparently been unable or unwilling to use pricing to keep to its balance sheet targets so that an excess supply of deposits has shown up as a declining loan/deposit ratio (and so lower net interest margin) rather than lower rates paid (and so higher net interest margin).

Deposit Policy at WFC

The results in Exhibit 3 suggest this is truer still of WFC, and more true at WFC than other banks. Indeed, WFC management encourages investors to focus on net interest income rather than net interest margin and on the benefits to its customer franchise, and opportunities for cross-sell, of attracting new and deeper deposit relationships. Over the last 3 years, WFC has shown strong deposit growth despite offering meaningfully lower rates than regional bank competitors (see Exhibit 4), and we view this as an indication of an advantaged franchise.

Exhibit 4: Deposit/Loan Growth and Rates across Regional Banks

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