The Fed's Recent Rate Cut: Implications for the Banking Sector

Impact on banks' net interest margins and credit quality

The Fed's recent rate cut is expected to compress banks' net interest margins, as evidenced by Wells Fargo's decline in net interest income and JPMorgan's deposit margin compression. Additionally, Bank of America reported increased credit losses, indicating potential credit quality concerns amid changing interest rates.

"Turning to Slide 4. Net interest income declined $1.1 billion or 8% from a year ago due to the impact of higher interest rates on funding costs, including the impact of customers migrating to higher yielding deposit products as well as lower loan balances, partially offset by higher yields on earning assets." --- (WFC, earning call, 2024/Q1)

"Net interest income increased, driven by the acquisition of First Republic, the impact of balance sheet mix and higher rates, as well as higher revolving balances in Card Services, partially offset by deposit margin compression reflecting higher rates paid across the LOBs, and lower average deposit balances in CCB." --- (JPM, sec filing, 2024/Q1)

"During the three and six months ended June 30, 2024, the total risk-adjusted margin decreased 108 bps and 147 bps primarily driven by higher net credit losses and lower net fee income, partially offset by higher interest margin." --- (BAC, sec filing, 2024/Q2)

"In the first quarter, net interest income decreased by $317 million, largely driven by markets, which resulted in a 4 basis point decrease in net interest margin." --- (C, earning call, 2024/Q1)

"Banking revenue increased 3% from a year ago, driven by higher investment banking revenue due to increased activity across all products, partially offset by lower treasury management results driven by the impact of higher interest rates on deposit accounts." --- (WFC, earning call, 2024/Q2)

Changes in lending practices and future strategies

Banks are adapting their lending practices post-Fed rate cut by focusing on efficiency and productivity, maintaining credit quality, and adjusting pricing strategies. They anticipate growth in net interest income and are encouraged by rising interest-bearing deposits, indicating a strategic shift towards optimizing lending activities.

"Tying our strong foundation together with our differentiated strategy, we feel we are well positioned for future growth. We expect meaningful structural tailwinds to net interest income due to anticipated maturities and repayments within our swap and securities portfolio." --- (CMA, earning call, 2024/Q2)

"And actually, as we continue to mature dividend finance and some of the lending businesses, we got to actually think that there is a reason that we'll be in the credit will continue to be better opposed to going the other direction." --- (FITB, conference, 2024/05/29)

"So my financing rate will go down so that my price will go up. Eventually, there's a market and I think that's going to affect not just M and A, but it will affect the basic loan market where people say, I got to run my company, I need working capital, I'm going to borrow because I got to have inventory and we'll get back in the normal cycle." --- (PNC, conference, 2024/05/29)

"We just did a CEO survey and we talked to clients. They are focused on productivity, efficiency, expense management, and the investments that they're making to the extent that they're utilizing lending activity is to really amplify some of that efficiency opportunity that they're focused on." --- (USB, earning call, 2024/Q2)

"In the meantime, we remain encouraged by our success in growing interest-bearing deposits and continued pricing discipline.Period-end balances in our securities portfolio, on Slide 7, declined, with continued paydowns and maturities as the mark-to-market adjustment remained relatively flat." --- (CMA, earning call, 2024/Q2)

Trends in customer deposits and savings rates

Customer deposit trends are mixed across the banking sector. While Zions Bancorporation reported a slight decline in deposits due to seasonality, Discover Financial Services and Capital One Financial noted significant growth, driven by strategic initiatives. Synchrony Financial anticipates continued deposit growth, reflecting overall positive trends in customer deposits.

"1% while average balances increased just under 1% for the quarter, led by growth in 1-4 family residential loans.Customer deposit balances declined just under 1% in the quarter on a period-end basis, reflecting internal -- or rather reflecting normal seasonality while our ratio of noninterest-bearing demand deposits to total deposits was flat to last quarter at 34%.Our common equity Tier-1 ratio was 10.6% compared to 10.4% in the first quarter and 10% a year ago." --- (ZION, earning call, 2024/Q2)

"Total loans increased 15%, customer deposits grew by 19% and payment services transaction volume was up 10%." --- (DFS, event transcript, 2024/05/09)

"Total deposits increased by $3.0 billion to $351.4 billion as of June 30, 2024 from December 31, 2023 primarily driven by our national consumer banking strategy, partially offset by an intentional reduction in lower margin deposit balances in our Commercial Banking business." --- (COF, sec filing, 2024/Q2)

"Through May, total average deposits have increased over $2,000,000,000 We expect this sustained deposit growth to continue over the course of the second half of the year and drive full year deposit growth to the top end of our guidance range between 3% 4%." --- (SYF, conference, 2024/06/10)

"Left side chart includes ending balance trends. Broker deposits were stable compared to the first quarter at $4 billion and were down $4.2 billion compared to the year-ago quarter as customer deposits have grown by $3 billion versus the prior year period. Compared to the preceding quarter, customer deposits were down slightly, reflecting seasonal trends in the second quarter." --- (ZION, earning call, 2024/Q2)

Regulatory implications of the Fed's rate cut

The Fed's cautious approach to rate cuts, emphasizing confidence in inflation control, suggests significant regulatory implications for banks. Concerns about maintaining deposit yields and managing balance sheets highlight the challenges banks face in adapting to these changes, impacting their profitability and client interactions.

"The Fed Chair emphasized the bank's intention to only cut interest rates once it has "gained greater confidence that inflation is moving sustainably toward the committee's 2% objective."" --- (NTRS, press release, 2024/07/30)

"But I guess also considering that even if we do get rate cuts, the Fed funds rate and the market rate is still going to be probably meaningfully higher versus kind of the available deposit yield that you and the industry offering?" --- (SCHW, event transcript, 2024/07/16)

"Remind us the positioning of the balance sheet if the Fed does decide to cut rates come September and we get 100, 150 bps of cuts?" --- (BK, earning call, 2024/Q2)

"And that is predicated on the points that you mentioned, which is that as you see rate cuts, we would expect those balances to stabilize." --- (MS, earning call, 2024/Q2)

"Jason Tyler: No, I'm saying that as we have rate cuts at this point, we -- that the -- we should be able to pass along those declines in the form of lower deposit yields to clients in our standard rate cards and in our negotiated rates." --- (NTRS, earning call, 2024/Q2)

Broader economic implications for the banking sector

The Fed's recent rate cut is expected to stimulate growth in investment banking and net interest revenue, despite some macroeconomic challenges. Banks are adapting to an innovation-driven economy and maintaining resilience, indicating a positive outlook for the sector's broader economic implications.

"And then moving to Investment Banking, where notwithstanding the fact that we are already the market leader, the business still has enormous potential for growth. And then financial sponsors, whose scale and role in the market is expanding each year." --- (JPM, event transcript, 2024/05/20)

"So NIR growth there, the investment banking pieces, the other driver of fees, we’re seeing that while it start to rebound, we’re part of that rebound, the announced transactions were part of those in sectors that we've been investing in." --- (C, earning call, 2024/Q1)

"And this whole innovation economy, you're banking the venture capitalists, you're banking to venture capitalist kids, you're banking the corporations they are financing." --- (JPM, event transcript, 2024/05/20)

"Banking and wealth, however, were negatively impacted by macro uncertainty, which led to an NIR decline that you see at the bottom of the slide. But one of the key takeaways on this slide is that despite the challenging macroeconomic environment, we were still able to deliver revenue growth." --- (C, event transcript, 2024/06/18)

"And when we think about higher for longer, maybe the economy is too strong, so we don't get any rate cuts, are you seeing that when you talk to your customers and the feedback you are getting from your bankers where the momentum is picking up?" --- (JPM, earning call, 2024/Q1)

Risk management adjustments in response to rate cut

In response to the Fed's recent rate cut, banks are enhancing their risk management strategies. Executives emphasize preparedness for market volatility, monitoring risk limits, and adapting to changing economic conditions to navigate the soft rate environment effectively.

"Having said that, markets and rates will likely remain volatile, and as risk managers, we are prepared if trends were to change." --- (WFC, earning call, 2024/Q1)

"Limits are monitored by Treasury and Risk. Risk is responsible for identifying and escalating to senior management and/or the appropriate risk committee, on a timely basis, instances where limits have been exceeded (e.g., due to positional changes or changes in market conditions, such as increased volatilities or changes in correlations)." --- (GS, sec filing, 2024/Q1)

"firm. Across the investment bank, navigating changes in the cycle means being deliberate around risk management and, given geopolitical uncertainty, where we spend our time to deliver clients, solutions, and to capture share.In wealth management, we continue to focus on aggregating assets and delivering strong advice." --- (MS, earning call, 2024/Q2)

"So we have 5, 6 factors that are countercyclical to rates and we tend to feel very good about those in a soft rate environment as long as the overall GDP growth environment is half way friendly to us as well as risk assets and markets behaving themselves. That gives us a very positive picture for our business going forward." --- (C, Investor Day, 2024/06/18)

"And so all of that creates risk management needs and active managers need to grapple with it and so on and so forth." --- (JPM, earning call, 2024/Q1)

Effects on bank profitability and capital reserves

The Fed's recent rate cut is expected to pressure bank profitability, particularly in retail banking, as indicated by Citigroup's concerns about profitability losses. However, major banks like Citigroup and JPMorgan maintain strong capital reserves, with Citigroup reporting $22 billion in reserves, suggesting resilience amid regulatory challenges.

"As such, we feel very comfortable with the nearly $22 billion of reserves that we have in the current environment.Turning to Slide 11, I'd like to take a moment to highlight the strength of our balance sheet, capital, and liquidity." --- (C, earning call, 2024/Q2)

"Year-over-year expenses were up 4% on revenue improvement and continued investment in the business.Finally, on Slide 18, all other shows a loss of $0.3 billion, and that was little changed year-over-year, as lower expense was offset by lower provision costs as a result of reserve changes." --- (BAC, earning call, 2024/Q2)

"The amount and timing of any future common stock dividends or repurchases will depend on the earnings, cash requirements and financial condition of the Company, the impact to our balance sheet of expected customer activity, our capital requirements and long-term targeted capital structure, the results of supervisory stress tests, market conditions (including the trading price of our stock), regulatory and legal considerations, including regulatory requirements under the Federal Reserve Board's capital plan rule, and other factors deemed relevant by the Company, and may be subject to regulatory approval or conditions." --- (WFC, press release, 2024/06/28)

"Other capital requirements Total Loss-Absorbing Capacity The Federal Reserve’s total loss-absorbing capacity ("TLAC") rule requires the U.S. GSIB top-tier holding companies, including the Firm, to maintain minimum levels of external TLAC and eligible long-term debt ("eligible LTD")." --- (JPM, sec filing, 2024/Q1)

"It would seem to imply that the retail bank is a huge drag on profitability even maybe even losing money, I don't know." --- (C, earning call, 2024/Q2)

Market reactions and investor sentiment post-rate cut

Post-rate cut, investor sentiment remains optimistic despite economic uncertainties. Key sectors like technology are favored, while banking strategies adapt to lower rates. Improved engagement and strong returns reflect confidence in the banking sector's resilience amid shifting market dynamics.

"Yet despite economic uncertainty amid the revised pace of rate cuts for the year, along with uncertainty around the 2024 election, investors remain optimistic about the market. The survey explored investor views on sector opportunities for the second quarter of 2024: IT – Amid continued interest in chipmakers and AI, technology remained the top choice for investors this quarter." --- (MS, press release, 2024/04/18)

"And so, if you think about the parts that priced up in Global Banking or the investment-related cash in the Consumer business and Wealth Management, that will come back down as rates come, because the short-term equivalents come down, some is absolutely mechanical because it's actually priced to meet a money market fund equivalent that will happen. And so, yes, I think if you think about us being all in, if you look on that slide at 203 basis points, there'll be some pickup as rates come down in those higher things." --- (BAC, earning call, 2024/Q2)

"Michael Grub: We received a question from James Amoroso who asks, what should the individual investor do with regard to the huge federal deficit and rising cost of servicing bad debt as interest rates continue to rise or hold steady? How should we invest to protect ourselves from this and inflation?" --- (JPM, event transcript, 2024/05/21)

"Amid market highs, how are factors like rates and equity volatility pushing top investors to shift their portfolio strategy?" --- (GS, twitter, 2024/04/05)

"Investor sentiment improved and clients were engaged. Our integrated firm delivered a 20% return on average tangible common equity, demonstrating the durability of our business model when markets are active." --- (MS, event transcript, 2024/05/23)