Despite the recent bank failures and market disruption, the Fed kept up the fight against inflation by raising the Fed Funds rate by 25 basis points to a range of 4.75% to 5.00%. This outcome reflects growing confidence in the measures taken to stabilize market conditions for banks as well as a continued focus on employment and inflation data. The March jobs report again came in hotter than expected. And while the inflation rate is gradually coming down on a year-over-year basis, the February month-over-month change in CPI was still +0.4% (+0.5% not including the volatile food and energy sectors). Indeed, the current inflation rate of 6.04% is approximately three times the Fed’s stated target range of 2% per year.
Markets still anticipate that the Fed Funds rate will decline in the second half of the year, with implied probabilities for December centered around a range of 4% to 4.75%. These are below the latest Fed dot plots that point to a most likely rate of 5.1% at the end of the year.
While we don’t have a crystal ball on where rates will ultimately land this year, we believe the range of possible outcomes has widened again. The health of both the right and left side of bank balance sheets, potential impact to lending and the broader economy, inflation and employment are all closely intertwined. How these dynamics play out over the coming months will influence the course of monetary policy for the rest of the year.
The Fed announced no change to the current pace of quantitative tightening. The liquidity impact of quantitative tightening may be partially and temporarily muted by utilization of the recently created Bank Term Funding Program (BTFP), which will inject liquidity into the economy through refinancing securities that are held in bank investment portfolios. The amount of any impact will depend on the degree to which banks use the facility.
This latest hike has important implications for bank deposits and interest rate risk management. In summary, it will increase both the speed and complexity of the deposit pricing decisions banks will face across segments. In retail portfolios, uncertainty in forward rates will raise the stakes on rate-based acquisition strategies, especially in CD offers. We expect wealth and commercial businesses to focus on risk diversification will result in more churn in deposit markets as well as increased demand for insured cash sweeps.
Bank treasurers will also be reviewing deposit weighted average life (WAL) models and the performance of liquidity risk models in light of recent market experience.
Retail | Commercial | Bank Treasury | Digital | Mortgage
Retail Focus: Already Accelerating, High-Tier Churn Ramps Up Further
Churn has picked up markedly in retail deposits since the third quarter of 2022, but the shifts have been uneven across balance tiers. While lower-tier customers (less than $100,000 in deposits) have shown steady moderate runoff consistent with inflation and spending patterns, higher-tier customers (those with more than $100,000 in deposits) have seen accelerated runoff that has been partly fueled by higher rates. (See Figure 1.)
The runoff in high-balance tier savings, critically, is not monolithic, though rate is the unifying factor. Flows within banks to CDs have increased, as have flows to direct banks and other rate offers. In addition, higher interest rates on loans have impacted high-balance customers, with notable paydown activity on variable rate loans and lines, and increased mortgage payments both for variable-rate customers and those who have taken on new home loans.
Even though fallout from the recent turmoil has been less intense than many worried, there may be echoing effects on both deposit growth and beta; early data suggest additional pressure ahead within the retail business.
The high-balance tiers have become even more volatile since the failures of Silicon Valley Bank and Signature Bank, though retail portfolios have seen less volatility than other segments. Balances with more than $250,000 had been declining an average of 0.7% per week since the start of the year, but the decline jumped to 2.5% for the week ending March 17. While the good news is that inflows from balances of less than $250,000 largely offset high-balance runoff within retail, increased churn puts additional pressure on retail deposit growth and betas. Ultimately, some degree of rate will be required to keep and attract these high-balance customers.
Notably, betas have also varied significantly by balance tier. For savings and money market deposits less than $250,000, the weighted average portfolio interest expense as of Feb. 28 was 0.36%, with 12% of balances priced at 1.00% or higher. For portfolios above $250,000, the weighted average portfolio interest expense was 0.91%, with 32% of balances priced at 1.00% or higher. As some customers look to spread their money around to move below insurance limits, pressure may increase on betas, particularly in the $100,000-$250,000 balance tiers.
Figure 1: Savings runoff accelerates in high-balance tier
Savings Balance Growth | $0-100K
Savings Balance Growth | $100K+
Commercial Focus: More Churn As Company Treasurers Look To Diversify Exposure
Prior to the recent disruption in deposit markets, this was set to be a year of increased competition for commercial deposits. Recent Curinos research showed that as of the first quarter, approximately 80% of commercial bankers expected negative commercial deposit growth during 2023. Conversely, about 60% of banks planned to grow commercial deposits on their own books. In short, this was a recipe for competition. Indeed, we were already seeing early signs of this with deposit betas accelerating in the first two months of the year (58% through the cycle for MMDA, and 46% through the cycle for IB DDA).
Recent events will likely dial up the level of competition for deposits at many banks even as the very largest institutions benefit disproportionately from flight to perceived quality. Why would this happen? It’s because company treasurers and business owners are more focused on diversifying their potential risk exposures to their banks. This may result in companies spreading their deposits more evenly across a larger group of banks. Additionally, there has been an uptick in interest in insured cash sweeps as well as increased flows into money market mutual funds and direct investments.
This doesn’t necessarily mean that regional banks will see higher deposit outflows. We would, however, expect that many will have to work harder on both offense and defense to maintain performance. This may also result in greater spread in performance between banks, both in pricing and growth. Winning in this environment will require banks to leverage a combination of sales practices, analytics and benchmarks that enable field decisions that are both speedy and data driven.
Bank Treasury Focus: Declining Deposit Life
Even before the events of the last two weeks, rapidly rising interest rates and lingering inflation pressures have shortened deposit WAL, a key behavioral metric monitored by bank treasury as part of ongoing interest rate risk and liquidity risk measurement and management. By our estimate, deposit WAL has shortened two-to-four years from the beginning of 2022, with variation by customer and product segment. The strongest WAL contraction has been observed in retail checking balances that have shortened just over four years at a time when deposit decay behaviors are measured on a 12-month rolling average basis.
We expect this trend of shortening to continue following the latest Fed action and the step-up in competition stemming from the importance of deposit liquidity after recent bank failures. Bank treasury must decide when and how to finetune WAL assumptions embedded in asset/liability models that produce key interest rate risk metrics and, in doing so, tell the story of the bank’s future asset or liability sensitivity. Banks that are relying on older, through-the-cycle WAL assumptions may be underestimating bank liability sensitivity and the challenges of growing/maintaining deposit bases in the coming months.
Digital Focus: Disruption Puts Spotlight On Money-Movement Capabilities In Commercial Platforms
As company treasurers and business owners sharpen their focus on the safety and security of their funds, digital platform capabilities play a key role. This includes providing into the cash position visibility as well as providing the tools to move liquidity between banks and in and out of off-balance sheet investments such as money market mutual funds.
These capabilities are especially important to middle-market and smaller bank customers who don’t necessarily have access to an advanced treasury management system (TMS) or a large in-house team to manage cash alternative investments.
Offering these solutions isn’t without complexity for banks. On the one hand, they make it easier for customers to diversify their credit exposures and maximize yield on their cash. On the other hand, they make it more challenging for banks to grow on-balance sheet deposits while keeping deposit costs down.
Still, this is an area where many regional banks are investing. And we anticipate that the events of the past few weeks will heighten client demand.
According to recent Curinos research, most banks offer a sweep to money market mutual funds today, although nearly 25% offer this product only selectively. (See Figure 2.) Tools for companies to execute self-directed investments into money market mutual funds or fixed income securities are less prevalent.
On the cash forecasting front, only 28% of banks broadly offer cash forecasting tools to their clients today; the same percentage of banks were already investing in building these capabilities this year. We expect recent events will increase demand.
Leading providers are also integrating artificial intelligence into their offerings and predict cashflows over a time horizon of two to four weeks. User experience will also be a differentiator as banks build these capabilities, including integration with self-help, customized filters and dashboards.
Figure 2: Bank Solutions Offered
With enhanced interest in companies optimizing their cash positioning, which of the following solutions do you offer?
Mortgage Focus: Opportunity In Providing Affordability Relief & Niche Lending
It’s clear that persistently high mortgage rates have curbed demand and it’s too early to tell if the spring season will result in the traditional pickup. Still, loans tied to affordability and those that serve niche markets are potential areas of opportunity.
With inventory shortages continuing to accompany elevated rates, affordability persists as a major impediment to home ownership even amid some price moderation. In fact, according to Goldman Sachs’ Housing Affordability Index, housing has never been less affordable. Fortunately, there are at least two factors that are helping to ease the burden.
First, a recent move by HUD to reduce the annual mortgage insurance premium by 30 bp on any FHA-insured mortgage is projected to save the average FHA borrower about $800 per year. Because these borrowers are typically first-time home buyers, the reduction could provide the incremental payment relief needed to foster affordability and drive loan demand. Curinos’ benchmarking data are already showing the FHA’s highest increase in lending activity, as a percentage of total volume, since before the pandemic. This indicator tells us that lenders would be well advised to renew their focus on FHA loan programs and positioning.
Second, co-investment, also known as home equity-sharing programs, is once again picking up steam. In such arrangements, an investor shares ownership with an existing or purchasing homeowner. Co-investment benefits an increasing number of existing homeowners who want to stay in their homes but need cash. It also benefits many first-time buyers who have waited too long and can’t afford the full asking price at today’s higher rates, which for lenders could widen the band of first-mortgage borrowers.
With rates showing no signs of easing, the affordability challenge will take time to subside. Meantime, it will be important for lenders to refine their offerings and stay close to industry-led initiatives, whether new affordability programs, reductions in mortgage insurance premiums or risk-based pricing.
Another opportunity for lenders to tap into loan demand is niche lending, which are loan programs such as medical/professional (commonly referred to as doctor loans), non-qualified mortgages (non-QM) loans and construction-to-permanent (c-perm). There is potential for increased volume from all of these programs, but it needs to be weighed against the potential credit risk and the need for additional qualification considerations that come with each.
