Quick Thoughts: The Signal from the Rate-Markets on 2015 Margin-Lift for Large Banks is Deafening
With 6-month Libor (6ML) at just over 30 basis points, the deposit franchises of US Commercial banks are contributing next-to-nothing to net interest margins; specifically, we estimate deposit franchises contributed less than 10 basis points to aggregate net interest margins of 3.1% in the first quarter (see table below). This will change in 2015 as rates back-up creating margin-lift and revenue-beats at large banks particularly those, such as WFC, with a weighting to “core” deposits.
Large-bank stocks are under-discounting a rate back-up in part because of skepticism about the Fed’s forecasts for recovery. For example, the Fed forecast is for a FF rate of 1.1% at end-2015 and 2.5% by end-2016 while the corresponding futures imply rates of 0.8% and 1.8% respectively. However, the gap is beginning to close with last month’s strong payroll data (creation of near-290,000 jobs) and consequent bring-forward by sell-side economists of the timing of Fed tightening.
Of course, the more relevant rate for bank deposit franchises is 6ML and the market signal is deafening: the forward rates are 1.8% for mid-2015 and 2.6% for mid-2016 vs. just over 0.3% today. These are extraordinary moves particularly given that they are not accompanied by meaningful flattening of the curve. Applying the 50% re-pricing beta (i.e. ratio of rate-increase on deposits to rate increase on short-term wholesale funds) of the last up-rate cycle to the $10tn of deposits held by US commercial banks suggests deposit franchises will add $75bn to after-tax earnings through 2016; this compares with total 2013 earnings for US commercial banks of $144bn.
There will be offsets as asset spreads continue to tighten (although bank executives are commenting that pricing may be stabilizing in the loan markets as demand improves and deposit outflow risk increases) and as the customary shift by savers to high-yield CDs occurs. Indeed, the latter will likely be more pronounced in this up-rate cycle given the impact of technology, including online services such as bankrate.com, on consumer switching (or “rate surfing”) behavior. For example, JPM is assuming a re-pricing beta in this up-rate cycle of 50% vs. 45% in the last up-rate cycle.
We agree deposit re-pricing betas will be 5-10% higher than historically but the dominant effect is variation across banks which will be greater than the already large divergence historically: in the last up-rate cycle, the beta was 33% for the best-performing quartile of the top-50 US banks while it was 78% for the worst-performing. We expect this range to widen in favor of large banks as they leverage information-scale and advantaged branch-networks to implement finely-segmented deposit pricing strategies and hence manage the trade-off between balance-formation and margin-enhancement. We note that this counter-consensus view on the value of branch networks is endorsed by a leading consultant: “the success of the largest banks in maintaining low volatility, low-cost deposits indicates that national banking capabilities (leading products and branch coverage) are most advantageous.”
Our 6/22 note, “The Role of Branch Networks and Information Scale in the Coming Deposit Re-price Cycle”, provides more detailed information on bank winners and losers.