The FOMC today announced a second consecutive 75 basis point (bp) increase, continuing aggressive rate increases that are intended to stem stubbornly high inflation. In addition to raising the Fed Funds rate, the FOMC also is continuing to ramp up the pace of asset sales, further tightening monetary conditions.
Central questions remain: when will inflation peak, how high will the Fed have to increase rates and how patient will the Fed be in its interpretation of economic data and trends? Additionally, we have seen other central banks response to inflation in recent weeks: ECB raised its benchmark rate by 50 bp, representing its first increase in 11 years and Bank of Canada increased by 100 bp. Bank of Japan, in the meantime, left its benchmark rate unchanged.
With the target Fed Funds range now 2.25% higher than the start of the year, the question many have been asking is “When will we see material customer and beta impacts?”
Based on the data we are observing at Curinos, it is clear that these impacts are now being felt.
Commercial and wealth MMDA/savings, the two segments that saw the earliest movement, are continuing to accelerate and are under pressure from money market mutual fund yields. Both of these segments have continued to show outflows and increased betas.
As of the end of June, commercial MMDA rates were up to an average of 47 basis points (bp), an increase of 20 bp from May 6. Direct bank deposit rates have also continued to increase, with the average of the top 10 rates tracked by Curinos increasing 35 bp to 1.37% between May 27 and June 24.
And in a new development, retail consumer deposit behavior, which remained stubbornly negligible through May, now shows significant signs of awakening from the hibernation of the last two years. Customer churn and rate-seeking behavior have emerged and potentially foreshadow a considerably more volatile second half of the year. Traditional banks enjoyed near-zero betas on consumer deposits to this point, but rates have now reached their highest level in more than 12 months and are poised to increase further.
There are three big issues that should be on all radars in the weeks and months ahead. How significant will commercial deposit outflows become? How quickly will consumer deposit behavior shift? When will banks have to raise standard deposit rates? The combination of these three dynamics will impact overall liquidity levels, deposit needs and, ultimately, overall beta levels.
The difference in position between banks will mean that performance continues to be differentiated across bank segments. The right strategy for one institution won’t necessarily be right for another.
And the window to plan for these events is shrinking. With more rate hikes expected, behavior shifts are poised to increase in velocity.
Are you ready?
Commercial Focus: The Reasons for Higher Deposit Betas
Average commercial deposit portfolio betas stood at 25% on average for interest-bearing portfolios through the end of June. To put this in perspective, the average bank has already incurred an incremental $37.5 million per year in interest expense per $10 billion of commercial interest-bearing deposits. While the increased cost of commercial interest-bearing deposits is already a material challenge for banks, there are several factors that could push betas higher following today’s hike.
First, 21% of commercial MMDA balances were already priced at or above 100 bp at the end of June. These depositors have demonstrated a high level of rate sensitivity already and we would expect them to continue doing so going forward.
Second, many banks are still sitting on a significant back-book of balances that have yet to re-price at all. As of end-June, 44% of commercial MMDA balances were priced below 25 bp. (See Figure 1.) But keeping these balances at ultra-low rates is likely unsustainable as the Fed Funds rate moves past 200 bp. For example, when the Fed Funds rate was at a similar level at the end of the last cycle, only 17% of MMDA balances were priced below 25 bp. Whether through changes in standard rates or large-scale repricing through exceptions, these balances are likely about to wake up. This will add several percentage points of upward pressure to commercial betas.
Finally, there is the impact of deposit outflows on pricing. The bottom quartile of banks by balance performance faced outflows of more than 2% per month through the second quarter. Many of these banks are paying much higher rates to stanch the outflows.
While our recent commentary has focused primarily on banks that are facing more severe deposit outflows, it is worth noting that overall commercial deposit balance performance improved in the second quarter. We attribute this to three factors: an increased willingness by a subset of banks to pay very high rates (over 100 bp) to retain balances, tailwinds to money supply from strong second quarter commercial lending growth and increased consumer spending. (See Retail Focus below.) Overall, these data support our forecast that total commercial deposit levels will likely end 2022 modestly down on a year-over-year basis, but that performance will vary significantly from bank to bank.
Figure 1: Percent of Commercial Deposit Balances by Rate Tier (Jun ’22)
Source: Curinos CDA
Retail Focus: Deposit Inflection Point is Here
The impact of spending and inflation continue to be the most significant story in retail. Inflation hit 9.1% in June, driving continued declines in checking and low-tier savings balances as mass market consumers dip into their financial cushion to pay normal expenses. Additionally, discretionary spending continues to increase through the busy summer vacation season as long-delayed plans are spurring “revenge spending.”
Up to this point, rate-seeking behavior has been minimal. Now, however, consumer behaviors have begun to shift although they are still nowhere near the heights of 2019. According to Curinos’ Comparative Deposit Analytics (CDA), the pace of savings and MMDA deposits switching to CDs increased substantially in June as customers seek higher rates. (See Figure 2.) While both metrics doubled their May values, they each remain under half of the peaks reached in 2019.
Rates have also increased above floor levels. While the changes are so far modest at traditional banks (rising three bp between May and June for savings/MMDA and seven bp for CDs), these moves are filtering down to the actual rate paid for the first time, with blended acquisition rates showing their highest levels in more than a year.
Still unclear is the pace at which consumer behavior will change. While inflationary pressures and lower industry deposit demand may point to a slower velocity than the last cycle, the pace and magnitude of Fed moves would portend a faster increase in rate-seeking behavior. Under either scenario, bank performance is likely to diverge over the coming months. Banks that can retain deposits and relationships with long-term value may pay modestly in the short-term, but will be rewarded as time goes on.
Figure 2: Percent of Consumer Savings/MMDA Balances Switching to CDs (Annualized)
Home Lending Focus: Banks Pivot from Mortgage, Independents Tap Home Equity
Home lenders are continuing to combat an uncertain market outlook amidst a global response to inflation. Despite recent, and much needed, incremental rate relief (Curinos benchmark data show conforming mortgage rates dropped 22 bp in the week ending July 10 from a month earlier), a majority of lenders have announced an additional round of layoffs. Furthermore, Sprout and First Guaranty Mortgage Corp (FGMC) abruptly ceased operations entirely.
The MBA now predicts an almost 70% decline in refinance volume this year, with its refinance index hitting a 22-year low. Not only has the rapid increase in rates tempered refinance demand in conjunction with a significantly contracted $2.2 trillion market, the departure of Sprout and FGMC suggest loan execution and the private markets may be considering other investment alternatives. This point is further highlighted in recent bank earnings; many large banks are making a strategic shift or right-sizing home lending. There is also the possibility of opening available balance sheet capacity for other lending opportunities, most notably home equity. Indeed, Curinos benchmarking data show that home equity volume rose 50% in June from a year ago.
In response to the improved home equity landscape and home equity rates that are now more attractive to many consumers than cash-out options, new market entrants are trying to capture some of this production. Guaranteed Rate recently rolled out a digital fixed-rate HELOC and Loan Depot plans to bring its digital HELOC to market later this year.
With the current presence of fintech disruptors and independent mortgage companies, the home equity landscape will become a larger focus for companies and provide ample opportunities to capture consumer demand.
Digital Focus: Are Your Consumer Customers in Control?
The country’s annual inflation rate hit 9.1% in June. Energy prices rose 41.6% from 2021, food costs surged 10.4%, new vehicle prices were up 11.4% and airline fares increased 34.1%. The Fed’s rate hikes and these macro factors are making it more difficult for consumers to get a clear understanding of their finances and control their spending. Budgeting tools that are constantly being updated by leading providers have the potential to make things just a bit easier.
As part of the industry’s shift from transactions to value-added services, budgeting tools are taking center stage in digital personal financial management functionality. Users can build budgets based on increasingly-specific categories, which they can monitor over preset and selectable timeframes. In-app alerts and notifications can be set up to make the customer aware they are approaching
each budget’s limit. Comparative periodical averages are presented against progress graphs or bars and recommendations made on surplus or deficit amounts to inform spend patterns and cross-selling opportunities.
Budgeting tools are an excellent way for consumers to control their finances and some banks are rolling out new and creative ways to eradicate outflows. More providers are adding the ability for customers to “hide” specific accounts so those stored funds are out of mind. A number of brands also have set maximum daily payment amounts.
While the average consumer might feel less confident in their ability to read external economic factors, advancements in digital banking from top providers can clearly help.