- Key insight: Banks had already been baking a potential interest rate hike into their outlooks. So some banks say the Fed's decision to raise the federal funds rate will have a neutral to slightly positive impact.
- What's at stake: Banks with variable-rate loans could see higher interest income in the near term. Still, higher rates will drive up deposit funding costs, compressing margins.
- Forward look: Additional rate hikes this year and next year could put further pressure on banks' funding costs.
Banks this week largely downplayed the Federal Reserve's first interest rate hike in three years, saying the range of outcomes could be neutral to slightly positive, at least on a near-term basis.
Ahead of the Federal Open Market Committee's meeting on Wednesday, where members
By and large, the banks maintained their earnings outlooks for the third quarter and the full year. And some bankers said the uptick in rates would prove beneficial, generating higher income from variable-rate loans.
How long they convey a sense of mild optimism remains to be seen. Sooner or later, higher interest rates are expected to drive up banks' deposit funding costs, compressing their margins and profitability.
But for now, banks such as Associated Banc-Corp and Ally Financial have a relatively rosy attitude.
Associated, a $52 billion-asset bank based in Green Bay, Wisconsin, continued to forecast margin expansion for the third and fourth quarters. It has been remixing its balance sheet by running off lower-yielding residential real estate loans and bringing on higher-margin commercial loans that come with commercial deposits, CEO Andy Harmening said at the Barclays Global Financial Services Conference.
He minimized the rate hike's impact, saying the bank is "in a pretty good position overall."
"We're slightly asset-sensitive, so on a very basic level, we make more money," Harmening said. "I think that'll help our margin a little bit … I don't think it does anything to dampen growth by going up … 0.25%. And I think overall it probably slightly expands our profitability."
Ally, based in Detroit, stuck by its guidance, saying the rate increase would be a positive for the bank's near-term performance. The $200 billion-asset bank has a "significant floating rate portfolio" that includes commercial auto loans and corporate finance loans whose yields adjust in "real time," Chief Financial Officer Russell Hutchinson said at the conference.
The rate outlook changed as inflation remained elevated and the war in Iran drove up energy prices. By midyear, an increasing number of banks were forecasting rate increases instead of reductions in their outlooks for the second half of the year.
The market is expecting "one more, maybe two more" rate hikes this year, said Mark Narron, senior director at Fitch Ratings. But he added that "the impact on banks is not going to be as important as it was in '22 and '23," when the Fed hiked rates aggressively to try to tame inflation.
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Between March 2022 and July 2023, the Fed increased the federal funds rate 11 times, taking it from near zero to between 5.25% and 5.50%. Banks grappled with higher deposit costs, which affected their profitability, eating away at net interest incomes and lowering net interest margins.
"It seems like [banks] have baked in net interest income growth, regardless of what happens incrementally on the rates side," Narron said. "It's really just a function of a lower-yield asset repricing at higher rates and swaps or whatever hedges they had rolling off, and it doesn't seem like [an increase of] 25 basis points is going to move the needle very much."
Still, consultants at Simon-Kucher predicted that rising interest rates would eventually lead to lower demand for loans and higher deposit rates.
"The general impact here is margin compression," said Rohan Shah, a partner in Simon-Kucher's retail and business banking group. "I think this is where smarter banks that don't do blanket (deposit rate) increases and have the ability to figure out who … requires a higher rate, I think those banks will win because their margins might not compress as much as others."
Several banks increased their prime lending rates Wednesday following the FOMC's decision. Associated, Regions Financial in Birmingham, Alabama, and KeyCorp in Cleveland each raised their prime rates from 6.75% to 7%. So too did PNC Financial Services Group in Pittsburgh; M&T Bank in Buffalo, New York; and Huntington Bancshares in Columbus, Ohio.
Huntington
At Ally, the plan is to "be disciplined on deposit pricing," Hutchinson said. "We'll manage our deposit pricing on the way up, to hold onto some of the benefits of those rising rates on the floating rate side of our business." The bank has implemented some rate increases on certificates of deposit, but its concentration in CDs has shrunk in recent years, he said.
Several banks at the conference spoke about heightened competition for deposits. That competition might be more impactful than higher interest rates, Narron said.
"I don't think there's an enormous amount of pressure to raise deposit rates, but that is what happens when the Fed hikes rates," he said. "People eventually start looking around and making some tough decisions as to where to keep more of their money."
Flagstar Bank on Long Island is one lender that's noticing the uptick in competition, according to Lee Smith, the bank's co-president, CFO and co-chief operating officer. To win its share of deposits, the $87.7 billion-asset bank is leveraging its relationships with commercial and private banking clients to bring on more noninterest-bearing deposits, Smith said at the conference.
"I think we're at an inflection point," Smith said. "Can we continue to grow deposits, but keep the cost of deposits relatively flat? So maybe [the Fed's interest rate] goes up a couple of basis points, but you don't see a big jump in the cost of deposits. That's what we're trying to aim for."
Given the growing expectation of additional rate hikes this year and beyond, banks will have to relearn how to move nimbly in a "restored normal rate environment," said Leo D'Acierno, a partner at Simon-Kucher. Following a long period of near-zero rates, the market has returned to a normal rate environment, and the cost of funds has a bigger impact on profitability, he said.
"That muscle of managing in an environment where the rates are going up, and there might be regular rate changes, that muscle at a lot of banks needs to be rebuilt," D'Acierno said.
"This is an incentive to rebuild it really fast."
