JPMorgan Is Poised to Pay Up for Deposits When Rates Rise

Don't count on a honeymoon phase for the cost of funds when rates rise — the second-largest holder of U.S. deposits certainly isn't.

Banks have spent the last few years dreaming of the day when the Federal Reserve starts to move interest rates higher. Most banks are at least somewhat asset-sensitive and are expecting to benefit from charging higher interest rates on loans before they have to pay depositors more to hold their money.

But Marianne Lake, the chief financial officer of JPMorgan Chase, predicted Tuesday that the company will have to pay more on deposits sooner than traditionally would have been the case.

"We are expecting retail deposits to reprice higher and faster in this cycle than in previous rising-rate cycles," Lake said. She added later: "When we think about our sensitivity and our reprice, we model ... that it's going to be higher — somewhat higher."

Lake outlined three reasons why. First, banks are demanding more retail deposits to strengthen their liquidity coverage ratios. Essentially, retail deposits are considered more stable. There is also an "awareness [among consumers] around low rates and the desire to participate in rising rates," Lake said.

Moreover, the adoption of mobile banking has made it much easier than in past cycles for bank customers to move money to chase rates, Lake said.

The influence of technology is a compelling factor, said Gerard Cassidy, an RBC Capital Markets bank analyst.

"In the '90s, if you wanted to move your deposits over to some place that would pay more, say to your Charles Schwab account, you'd have to mail a check and in the last rising-rate environment, 2004 to 2006, it became easier because you could do it from your desktop," Cassidy said. "But now, you can turn on your smartphone and with the touch of a couple of finger points you can move whatever you have left over very easily."

Easier-to-make transactions also mean consumers need less prodding to act, Cassidy said. For instance, getting paid 25 basis points more may not have motivated depositors a decade ago, but it could today.

As it awaits higher rates, JPMorgan is tinkering with its balance sheet. It ran off more than $100 billion of what it has deemed "non-operating" deposits across its wholesale commercial business. That is a term for deposits, like a commercial business's cash on hand, that are less likely to stick around and provide long-term sources of funding.

New regulations would have prompted the bank to invest such deposits into assets that could be quickly turned into cash if needed. At June 30 the company's deposits were $1.29 trillion, down from $1.36 trillion at the end of 2014, with a $28 billion increase in retail deposits helping to offset the reduction of non-operational runoff.

Meanwhile, assets contracted to $2.45 trillion, down roughly $123 billion from yearend. At nearly $90 billion, cash made up the bulk of the reduction and was partially offset by $34 billion in loan growth. The cash reduction was "a huge positive" for the company because it earns little, Cassidy said.

Turns out less was more for JPMorgan, as the balance-sheet changes helped push up its net interest margin by two basis points from the previous quarter, to 2.09%.

"They told us that they would make substantial progress [on the non-operating deposit reduction] and they did," said Ken Usdin, an analyst at Jefferies. "They removed a lot of the burden on the balance sheet in terms of excess deposits that they did not have the ability to remediate into loans. As a result, we have net-interest-margin improvement via shrinkage and a better mix of earning assets."

JPMorgan is cautiously considering whether to jettison more of the non-operating deposits, Lake said.

"We've always said that we want to do this for the right reasons, for capital efficiency, but not do it in a way that's going to materially harm our clients," Lake said.

Overall, the company reported earnings of $6.29 billion, up 5.2% from a year earlier. At $1.54 per share, the earnings beat the expectations of analysts surveyed by Bloomberg by nine cents. The earnings were driven by lower expenses despite lower revenue.

Revenue fell 3%, but several analysts said they were pleased by the company's loan growth. Core loan increased 5% from the first quarter and rose 12% from the second quarter of 2014. Core loans only include those the company deems central to its ongoing businesses and excludes loans from lines the company has discontinued or plans to exit.

Lake noted that portfolio-held mortgages, especially jumbo ones, were among the highlights in quarterly loan growth.

That is consistent with other large banks that are booking such mortgages to add interest income, even if it means "sacrificing some of the long-term asset sensitivity," Usdin said.

"It is about managing near-term returns while preserving long-term asset sensitivity," Usdin said. "Every bank is trying to be thoughtful with that balance."