Five big questions as banks await Fed's rate cut

Banks anticipate getting some relief on deposit costs as the stiff competition to land customers' money over the last two years eases up. Lower interest rates should mean that people won't expect as much bang for their buck and may have less incentive to shop for high yields on their cash.

Although higher rates also allowed banks to charge more interest on loans, decreased borrower demand meant that interest income didn't keep pace with the price of deposits. That imbalance compressed net interest margins — the difference between what banks collect in interest and what they pay to depositors.

Financial institutions have steadily been making moves to fight high deposit costs, especially since abundant funding has become less vital amid tepid loan demand. Some companies, such as Ally Financial, Discover Financial Services and Goldman Sachs, began trimming high-yield savings programs earlier this year.

Still, most banks signaled that one, or even two, rate cuts wouldn't immediately put a lid on margin compression from deposit costs.

Ally, for example, isn't counting on rate cuts to start generating upside on the liability side of its balance sheet, according to Chief Financial Officer Russ Hutchinson. The $193 billion-asset bank is guiding for its net interest margin to tick up as its funding costs go down and it bulks up on higher-earning loans.

John Woods, the CFO at Citizens Financial Group in Providence, Rhode Island, said on the $220 billion-asset company's second-quarter earnings call that deposit pricing pressures will continue to "bump along" until the Fed cuts rates, adding that the first Fed rate would be "helpful."

JPMorgan Chase also offered a wary outlook on deposit costs. CFO Jeremy Barnum Barnum cautioned that deposit margins, which are "well above historical norms," would continue to compress profits going forward.

Bank of Marin, a $3.7 billion-asset bank in Novato, California, is managing its deposits by pulling out of the competition for "rate shopper money," said President and CEO Tim Myers.

"We will cautiously look to allow deposits to run off that are overpriced," Myers said.

High borrowing costs have been contributing to the sluggish loan demand that bankers have been reporting in recent quarters. In the first quarter, the industry-wide year-over-year loan growth rate was 1.7%, according to the Federal Deposit Insurance Corp. — the lowest quarterly growth rate in two and a half years.

The question now is whether the Fed's first rate cut will make a significant difference.

David Antolik, the president of S&T Bancorp in Pennsylvania, expressed optimism about the likely impact of rate cuts. As commercial customers anticipate a decline in borrowing costs, "they're looking at the possibility of refinancing or moving forward with projects," Antolik said.

Similarly, Peter Sefzik, the chief banking officer at Comerica, said that the Dallas-based company's surveys of customers indicate that interest rates are the top driver of loan demand. But he also pointed to business owners' uncertainty about the outcome of the presidential election as another deterrent to borrowing.

"I think probably real demand doesn't pick up until you start to see interest rates come down and we get through the election," Sefzik told analysts in July.

Though mortgage rates are down a bit from their peak last year — the 30-year fixed-rate mortgage rate sat at 6.35% in late August — they are still higher than they were at any point between 2009 and mid-2022.

The upshot is that the math of refinancing doesn't work for most homeowners. And bankers are warning that a 25-basis-point cut by the Fed, or even a 50-point cut, won't revive the refinancing business.

William Furr, the chief financial officer of Dallas-based Hilltop Holdings, said on a recent earnings call that the largest block of the company's customers currently have mortgage rates below 5%.

"So the first 25 basis points — even the first 100 basis points of reduction by the Fed — we don't actually see, or aren't actually projecting internally, that we're going to have a material rebound in refinance activity," Furr said.

KeyCorp CFO Clark Khayat gave the same assessment, saying that rates will "have to come down quite a bit, frankly," to spur a lot of refinancing activity.

There is a silver lining for banks that offer home equity lines of credit. Brendan Coughlin, vice chairman and head of consumer banking at Citizens, said that high rates and high levels of mortgage equity on homeowners' household balance sheets have contributed to "very strong HELOC growth."