Banks are fighting to keep deposits. At what cost?

Bank deposit rates are the highest in a decade and a half. That’s good news for savers, but bad news for lenders as they prepare to release their second-quarter results.

US banks spent the last several months competing with each other to keep or bring back depositors following the turmoil that took down three sizable regional institutions and triggered outflows across the banking system.

That scramble pushed rates on savings accounts to 5.05% at the end of the second quarter, according to Bankrate, their steepest level since February 2008.

Read more: The best high-yield savings account rates for July 2023

The challenge for banks across the US is that these higher funding costs are eating into a key measure of profitability known as net interest margin, which measures the difference between what lenders make from their loans and what they pay for their deposits.

That will likely act as a drag on results for some banks in the quarter, especially the mid-sized regional institutions that ran into trouble last spring, while reducing estimates of what they can earn for the rest of the year.

“The surprises this quarter will be for the banks that do not lower expectations,” Wells Fargo bank analyst Mike Mayo told Yahoo Finance.

Banks, added Argus Research's Stephen Biggar, "have a deposit conundrum."

'Green shoots'?

These pressures will be at the front of mind for investors starting Friday as they digest the first set of second quarter earnings from JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), and State Street (STT).

Bank of America (BAC) and Morgan Stanley (MS) report next Tuesday and Goldman Sachs (GS) next Wednesday. A slew of other regional banks will also report in the coming weeks.

Some of the biggest US banks are expected to once again demonstrate their resilience and diversity, showing they can continue to charge more for their loans while leaning on their sprawling franchises to generate additional revenue.

JPMorgan, Wells Fargo, and Bank of America are all expected to show jumps in net income when compared to the year-earlier period, according to analyst estimates, while Citigroup, Goldman Sachs, and Morgan Stanley are expected to report profit declines.

FILE - In this Oct. 21, 2013 file photo, the JPMorgan Chase & Co. logo is displayed at their headquarters in New York. JPMorgan Chase announced a settlement with the sex victims of financier Jeffrey Epstein, the bank said Monday, June 12, 2023, which had accused the bank of being the financial conduit that Epstein used to pay off his victims for several years. (AP Photo/Seth Wenig, File)
JPMorgan's headquarters in New York City. (AP Photo/Seth Wenig, File) (ASSOCIATED PRESS)

Those that are more dependent on investment banking, such as Goldman, are expected to be particularly challenged by a recent drought in deal making.

Global investment banking revenues for the second quarter fell by 8% from the first quarter and 52% from a year ago, according to Dealogic. However, the business improved through the second half of the quarter, prompting some observers to predict “green shoots” ahead.

“I’m turning to believing investment banking will not have great earnings but they’re going to be surprising, and I think better than expected,” said Dick Bove, a bank analyst with Odeon Capital.

Investors will also be watching to see whether many of these big banks increase the amounts they set aside for future loan losses, a sign that they expect the US economy and credit conditions to worsen.

“We're starting to see some increased delinquencies, particularly in the credit card and auto lending market,” said Biggar, Argus Research's director of financial services.

'A huge amount of problems'

Smaller regional banks are clearly not under the same amount of pressure as they were in March, when the fall of Silicon Valley Bank triggered panic across the country.

But they still “face a huge amount of problems,” Bove said.

The core issue is an aggressive campaign by the Federal Reserve to bring down inflation with higher interest rates. That campaign is lowering the value of the assets banks hold, such as bonds, while deposit costs creep higher and loan demand slows.

Read more: Why now is a good time to open a savings account

“We view accelerating deposit costs, not accelerating deposit outflows, as the most significant headwind to earnings for the next several quarters,“ Manan Gosalia, a regional bank analyst for Morgan Stanley, said in a research note.

Higher rates have traditionally worked to the advantage of banks since it allows them to charge more for their loans than their deposits.

But the panic of the spring “has changed the calculus a bit” for some banks, the Fed’s vice chair of supervision Michael Barr said Monday. Some lenders “are now paying up more for deposits,” and the Fed is “paying careful attention to that.”

FILE - People stand outside a Silicon Valley Bank branch in Santa Clara, Calif., on March 10, 2023. The recent collapse of a trio of midsize banks, including Silicon Valley Bank, has once again raised questions on whether executive compensation is tilted toward short-term gains rather than companies' long-term health. (AP Photo/Jeff Chiu, File)
Silicon Valley Bank was seized on March 10. (AP Photo/Jeff Chiu, File) (ASSOCIATED PRESS)

The Fed has made it clear that more hikes are coming this year. Regulators are also preparing new capital requirements for banks with more than $100 billion in assets that will force some to hold greater buffers against losses. That will increase the stability of those lenders but will also make it even more difficult to earn robust profits in the near term.

Many banks have already warned at a conference in June that their net interest margins are going to drop by more than they expected for the quarter or the year, including executives for US Bancorp (USB), Citizens Financial Group (CFG), Comerica (CMA), Huntington (HBAN), KeyCorp (KEY), and Zions (ZION).

“I’ve only been a banker for 10 years, so I haven’t seen a time when we’ve needed deposits as an industry as much as we do now,” Darrin Williams, the CEO of the 58-branch Southern Bancorp, told Yahoo Finance.

The amount Southern Bancorp is paying customers has risen 600% since the Fed’s interest rate hiking cycle began, Williams added.

“Our cost of funds continues to rise just because our customers demand that.”

The larger banks aren’t immune to some of these same challenges.

“Deposits will continue the trend of being slightly down from here,” Jennifer Piepszak, co-CEO of JPMorgan Chase's massive consumer and community bank, said at a conference in June.

The bank has predicted it will earn net interest income of $84 billion in 2023, but if the deposit pressure keeps up, that figure could experience a “mild reprice,” she said.

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