After watching margins slide for the better part of a decade, bank CEOs are cheering news that the Federal Reserve is hiking rates sooner than expected just weeks ago.
When the Fed on Wednesday boosted its benchmark short-term rate by 25 basis points to between 0.75% and 1%, it was the second such increase in three months after just one in the decade prior. The central bank also said it expects interest rates to settle around 3% by the end of 2019, slightly earlier than it had predicted in December.
Small-bank CEOs said the latest rate increase will give them a much-needed opportunity to boost deposit rates to stay competitive in their local markets. Yet several of their larger peers emphasized the importance of keeping deposit prices low to capture the benefit of higher loan revenue.
Still, for executives across the industry — and particularly at small lenders, which rely heavily on interest income — one thing is clear: After several years of lackluster margins, the Fed’s latest move is a welcome change of pace.
“We’re so dependent on the net interest margin that any increase in rates” makes a significant difference, said James Sills, president and CEO of the $256 million-asset M&F Bancorp in Durham, N.C.
The Fed’s decision to boost interest rates is a signal that the economy is on the cusp of gaining steam, he said. Community bankers “are going to have to follow the market a little closer,” Sills said.
The rate hike Wednesday comes as margins have hovered around historic lows, though they have begun to increase slightly. The average net margin across the industry rose 6 basis points in the fourth quarter to 3.13%, the Federal Deposit Insurance Corp. said in February.
They are still short of pre-crisis highs. As recently as 2010, margins across the industry exceeded 3.8%.
The Fed action coincides with an improved sense of optimism among CEOs and investors about the pace of future economic growth. The stock market has surged in recent months, following the election of President Donald Trump. The KBW index has climbed more than 30% since November, in part on expectations that Republican leaders in Washington will slash corporate taxes and scale back regulations.
The interest rate increase will put a spotlight on net interest income at banks in the months ahead. During JPMorgan Chase’s annual investor day last month, Chief Financial Officer Marianne Lake said the company could add as much as $12 billion in additional net interest income if interest rates reach 3% by 2019.
In 2016, net interest income at the $2.5 trillion-asset JPMorgan grew 6% from a year earlier, to $46 billion.
Additionally, deposit pricing will be a key area of focus. Bank CEOs now face the tricky push-and-pull of keeping their deposit costs low while also meeting customers’ demands for competitive yields.
Some banks, such as the $125 billion-asset Regions Financial in Birmingham, Ala., will wait as long as possible before they raise deposit prices.
“Our deposit base is really a competitive advantage for us … and it’s up to us to be able to extract appropriately the value" out of that base, CFO David Turner said on March 7 at the RBC Capital Markets Financial Institutions Conference. “We have to be competitive, and we will be, but we don’t have to rush the increased rates.”
Other financial institutions, like the $4.5 billion-asset Middlesex Savings Bank in Natick, Mass., are prepared to reward customers sooner.
“We’re in business for our depositors and our borrowers, and we feel like it’s the right thing to do,” CFO Brian Stewart said in an interview Wednesday.
Middlesex raised deposit rates immediately after the previous two rate hikes, “and we didn’t see many followers,” Stewart said. However, Stewart acknowledged that mutual thrifts like Middlesex Savings have more flexibility to pay higher deposit rates.
“Publicly traded banks are under more pressure to pay dividends or buy back stock” and therefore have more need to wait on raising deposit prices, he said.
Banks that possess a high proportion of core deposits, like the $73 billion-asset Comerica in Dallas, will not give those up lightly. Comerica held $2.8 billion of more expensive time deposits at Dec. 31, or about 4.7% of its total deposits, compared with 15.1% for its peers, according to BankRegData.com.
“The bulk of our funding comes from nonmaturity customer deposits, which results in one of the lowest costs of funding among our peers,” Chairman and CEO Ralph Babb said on March 7 at the RBC conference. “We believe our low-cost base provides a competitive advantage and should become even more valuable as interest rates rise further.”
Comerica has been able to hold off on raising deposit costs due to sluggish loan demand, which has meant that many banks still have high levels of liquidity, CFO David Duprey said at the RBC conference.
Other publicly traded banks have recently echoed Comerica’s remarks about deposit pricing remaining stable, including the $124 billion-asset Northern Trust in Chicago; the $100 billion-asset Huntington Bancshares in Columbus, Ohio; and the $1.2 billion-asset Provident Savings Bank in Riverside, Calif.
“We haven't seen tremendous pressure in our markets with respect to deposit rates,” Donavon Ternes, Provident’s chief operating officer and CFO, said during an earnings conference call on Jan. 30. “But, by and large, there has been relatively good deposit-rate discipline.”