The drag on bank profits from higher interest rates seems close to abating, as the industry looks to slash payouts to depositors when the Federal Reserve cuts rates.
After years of getting paid very little on deposits, consumers and businesses had
Less competition means they don't have to pay up to attract depositors, who are now seeing slightly lower rates on their certificates of deposit and online-only savings accounts. The rate drops are still small — after all, the Fed has yet to pull the trigger on cutting interest rates.
But the Fed may do so as early as next month, analysts predict, a move that would give banks a breather after last year's deposit wars caused them to shell out more interest payments to depositors.
"What goes up must come down," said Eric Chan, an analyst at the ratings firm Morningstar DBRS.
High deposit costs have
The median net interest income at midsize and regional banks was still down 1.2% from last year, but it rose nearly 1.9% compared to last quarter, RBC Capital Markets analyst Jon Arfstrom wrote in a note to clients.
"We have long called for an inflection in margins and net interest income occurring this quarter, and trends were generally consistent with our expectations," he wrote.
The new CDs: cheaper and shorter
Some early
More banks are now testing the waters on whether they can lower rates — just enough for the bank to save money but not too much that depositors will be upset. After offering CDs that paid annual interest rates north of 4.5% or even 5% last year, bankers have been able to pay a little less and still keep clients.
"They have been successful in retaining the vast, vast majority," said Matt Pieniazek, president and CEO of the bank advisory firm Darling Consulting Group. "In some cases, we're hearing 95% and above."
The average rate that banks are paying on new CDs dropped from 4.9% last year to 4.75% at the end of June, according to data from hundreds of banks and credit unions that Darling Consulting works with.
The industry is also continuing to shorten the length of the CDs they are using to attract consumers. Rather than saddling themselves with paying today's high rates on a CD that stretches over a year, they are focusing on offering CDs of six months or less.
The hope is that, once those six months run out, the Fed will have cut rates significantly and banks can switch those expiring CD customers into lower-paying ones.
"This should allow the banks to quickly reprice deposits down once the Fed starts cutting," Morgan Stanley analyst Manan Gosalia wrote in a research note focused on midsize and regional banks.
Is the worst of it over?
It's "time to lean into midcap banks," Gosalia wrote to investors. After deposit costs eating into their earnings, mid-size banks are likely to see their interest income inflecting and going higher each quarter as the Fed cuts rates, he wrote.
Some banks may still have to pay up for deposits if they are short on cash or looking to expand, even though softer loan demand has made growth harder. The Fed is also sticking with
But beyond the consumer space, there are other signs that the sharp rise in funding costs that pinched banks last year is easing.
There is stabilization in the brokered CD market, where banks can turn for additional but more expensive funding, Janney Montgomery Scott analyst Christopher Marinac wrote in a recent note to clients.
Banks haven't been as lucky in persuading their business customers to accept lower rates, Marinac wrote. But their "exception-based pricing has eased," he added, an encouraging sign that bigger clients can't demand sweeter one-off interest deals as easily.
Investors "should recognize rising credibility" of stability in banks' interest margins, which should start ticking up in the coming months, Marinac wrote.
The so-called mix shift in deposits also seems to be getting better. As interest rates rose, consumers moved money away from accounts that paid no interest toward those that did. The shift is still happening but appears to be approaching the floor, RBC's Arfstrom wrote.
Lingering competition will still weigh on banks, he wrote, as will continued uncertainty on the path of interest rates. But at least for now, bankers have "increased comfort" that the worst has passed, he wrote.
"We continue to be broadly optimistic about the direction of margins going forward, and we expect the path for most regionals to be stable to biased higher from here," Arfstrom wrote.
