The Fed today took an aggressive step intended to slow inflation, increasing the target range for the Fed Funds rate by 75 basis points to 1.50-1.75%. The move was the largest increase since 1994; additional increases are expected in July and September. With rates passing the important 1.00% threshold and increased customer awareness due to the historic increase, past trends would suggest customers are beginning to seek more attractive yields.
Tracking customer behaviors and bank responses through the first 75 bp of increases, early reactions have been relatively modest, although there have been pockets of higher rates beginning to show in some commercial portfolios. While the banking industry overall continues to show excess liquidity, competition is beginning to emerge.
First, money market mutual fund (MMMF) yields have risen off floor levels, with the highest-yielding money funds above 0.70% as of June 1. These products, while not on the radar of the average mass market consumer, are very often in the consideration set for high net-worth investors and corporate treasurers. The pressure from MMMF yields has already led to an increase in exception pricing requests from wealth and commercial deposit customers.
Second, direct banks continue to increase rate aggressively, with an average increase for online savings now exceeding 0.40%, according to Curinos Standard Rate data. Top-of-market rates now exceed 1.00%, with the largest direct banks also nearing this important milestone. As more direct banks pass the 1.00% threshold, Curinos expects churn to begin to increase among mass market customers as well.
The net effect of the uneven competition is leading to an increasing “barbell” effect. While the majority of deposits continue to earn 0.10% or less, small pockets are earning 0.50% or more and sometimes as high as 1.00%. This structure may continue to deepen in the near term, but offers longer-term risk as the top of market continues to increase and the gap between the two ends of the barbell widens. As this happens, pressure on the lower end will increase and the rate required to retain a customer will increase as well. The continued development of plans to respond to this pressure will be critical across all segments.
Retail Focus: Little Movement Yet, but New Threshold is Key
Within the retail segment, both internal and external churn have remained low because most consumers are not yet showing yield-seeking behavior. Betas have lagged across nearly all traditional banks, with average rates for savings and money market deposits (MMDA) remaining below 0.05%. Retention efforts have mostly focused on CDs, with 22% of banks now offering a short-term CD rate above 0.50% and 6% offering a 1.00% rate, according to Curinos data.
The situation is different in the wealth sector, where exception pricing has increased for the largest, most valuable depositors. Rates in the $5 million deposit tier are up 11 bp through April 30, according to data from Curinos Wealth CDA. Although they are still well below historical rates, pressure is likely to increase over the coming weeks.
Churn tracking and retention planning will become increasingly important as rates pass the critical 1.00% threshold. Institutions will need to track deposits switching — both internally and externally — along with the value of relationship in order to know when to respond. Banks will also need to determine who to retain and how high they are willing to price to save a valuable customer.
Figure 1: Direct Bank Savings and 12-Month CD Rates
Average of Top 10 Direct Bank Rates Jan ’22 – May ’22
Source: Curinos Standard Rate Data, includes 69 internet banks | Simple averages displayed
Figure 2: Savings/MMDA Switch to Higher Rate
Source: Curinos Consumer CDA
Commercial Focus: Betas and Outflows are Picking Up
Through-the-cycle interest-bearing betas are picking up to 20% on average, but with a wide variance across banks. Those that started the cycle with the lowest rates have been able to lag most successfully. The bottom quartile of banks by average interest-bearing rate paid have seen betas of just under 10%, while the average has been 19% for IB DDA and 21% for MMDA. Meanwhile, those that began the cycle in the top quartile by rate paid have passed through betas of 27% for IB DDA and 39% for MMDA.
We’re also seeing significant differences in balance performance. On average, commercial deposits were down 4% through the first quarter, according to Curinos Commercial CDA. The bottom quartile of banks by balance growth experienced commercial outflows of 10% on average during the first quarter.
These data align with our expectations that banks will fare differently throughout the year based on the quality of surge deposits acquired over the past two years, the concentration of primary customer relationships within their books and their deposit management capabilities inclusive of analytics, access to benchmarks and exception pricing governance.
Looking ahead, commercial deposit management will get harder, not easier, as the Fed accelerates the pace of quantitative tightening and banks begin to contemplate standard rate increases. Unlike the prior rising-rate cycle, in which virtually all beta was driven by exception rates, keeping standard rates flat this time will likely be an untenable position by year end.
Figure 3: Betas Segmented by Avg. Portfolio Rate (March 2022-May 2022)
Source: Curinos Commercial CDA
Home Lending Focus: Affordability and Profitability
Higher rates have undoubtedly constrained the purchasing power of consumers today. Just six months ago, first mortgage rates were around 3.00%. As of the first week of June, Curinos Benchmarking data reflect an average rate of 5.25%. Couple this exponential rise in rates with persistent near-record home price appreciation and it is clear that many new and existing homeowners are being priced out of potential real estate transactions. According to the Mortgage Bankers Association’s application index, weakness in both purchase and refinance applications have pushed their index to the lowest level in 22 years.
With respect to payment shock specifically, Curinos Benchmarking data reflect a 25% increase in the average mortgage payment between the second half of 2021 and now — not accounting for any sort of home price appreciation. (See Figure 4.) When considering the current supply imbalance as a result of labor shortages and supply chain bottlenecks, a cooling of demand may be needed to achieve a stronger equilibrium in the housing market.
From a strategic perspective, lower mortgage origination and production continues to force lenders to innovate products and offerings to entice consumers. More affordable lending programs and more affordable housing are paramount as we confront this new reality of higher rates.
Meanwhile, competitive pressures continue to intensify. First-quarter earnings revealed that those with positive earnings got a boost from their mortgage servicing valuations (higher rates increase servicing values) or sold some servicing to remain profitable.
As the Fed continues to stay the course and combat inflation vis-à-vis rate hikes as well as balance sheet management, the real question will be how much the market can withstand before a dampened housing market contributes to slower economic growth. Keep in mind that housing tends to lead most economic recoveries.
While many have started to resurrect the word “recession” (consensus sometime in 2023), the path forward may not be as clear as many would hope. Global collective efforts to combat inflation have a profound impact on both the lending marketplace, as well as overall economic growth prospects. Lenders should remain cautious, however. Those that sustain discipline should find ample opportunity to innovate and gain a competitive edge within this rising-rate landscape.
Figure 4: Average Mortgage Payment (in $)
Note: Owner-occupied, conforming and government rate locks as of 5/27/22
Source: LendersBenchmark first mortgage originations data
Higher Rates Put Focus on “No-Code” Technology Stacks
“No-code” has become the latest trend shaping the vibrant banktech community. Many products and services now sit on no-coded platforms that present a particularly attractive option for banks that want to quickly upgrade their propositions as rates change and customers start searching for higher yield.
The no-code appeal is that the software automatically evolves and drastically shortens technical integration time – a huge advantage for lenders leaning on cumbersome legacy systems.
Across their digital offering, vendors now offer plug-and-play or no-code tools across payments, compliance and various points of the onboarding and servicing experiences. These plug-and-play or no-code solutions lend themselves to back-office or core functionalities where standardization is championed, such as data management and compliance, or where specializations sit outside a bank’s reach, such as machine learning or artificial intelligence.
At the front end, such as in-app and online, these solutions can allow an institution to quickly add new customer-facing tools or services. When agility becomes imperative, a bank might find a quick and natural solution by working with a no-code vendor.
That said, as far as discerning customers are concerned, digital banking is built on innovation and originality is championed. The vendor must be able to offer near-complete customization that allows the institution to tailor the solution completely differently to the vendor’s other clients. After all, distinctiveness is important to retain and acquire new customers. The business must carefully consider the balance between differentiation and ease of integration — a common dilemma that organizations face on their path through digitization.
Without doubt, no-code has evolved the relationship between financial institutions and their vendors. An agile tech stack is appealing to lenders that are particularly sensitive to rate changes. Nimble vendors that provide the building blocks for sprightly business change can pay off over the short term, but they must also offer their banking clients the ability to tailor any front-end solutions so they can offer unique propositions. At this stage in the evolution of digital banking where fintech and fast-moving lenders are beefing up their in-house capabilities, this is increasingly important.