A Surprising Shakeout Among Banks as Rates Rise

Ordinarily giants like Bank of America are slower to raise deposit rates, but this time is different

By Aaron Back  

So far this year, the average cost of interest-bearing deposits at big banks like Bank of America has gone up by 0.18 percentage point, bigger than the average increase at large regional lenders. Photo: Richard B. Levine/Zuma Press 

When the Federal Reserve began raising interest rates, every bank was a winner. As the Fed prepares for its fifth rate boost, some banks are benefiting more than others.

When rates start to rise, banks are typically in no rush to raise their deposit rates. After several increases, banks have to pay out more to depositors or risk seeing them leave in search of higher yields.

Amount that deposit rates rise, as percentage of Federal Reserve rate increase

We have hit that point now, but it is playing out in a surprising way, according to analysts at Keefe, Bruyette & Woods. So far this year, the average cost of interest-bearing deposits at big banks like Bank of America BAC -0.72%▲ and J.P. Morgan Chase has gone up by 0.18 percentage point, compared with a 0.10 increase at large regional lenders like SunTrust Banks , KBW calculates.

The so-called deposit beta, which measures how much banks raise their rates as a percentage of the Fed rate increase, reached 34% for universal banks in the third quarter, up from 16% in the first quarter. But large regional lenders and small banks have seen a more gentle response, with deposit betas hitting 18% and 20% respectively, in the third quarter.

Ordinarily giants like Bank of America are slower to raise rates, thanks to their strong brand and market positions. The difference this time is these banks have been pushing to serve wealthier clients who are more likely to move money around in search of higher yields.

KBW analyst Christopher McGratty says he expects smaller banks to catch up as awareness spreads among depositors that they can earn more. Smaller banks also are growing faster and have higher loan-to-deposit ratios, so their need for funding is greater.

In a rising rate environment, differences in business models, regardless of size, become more important. Banks that focus on commercial and industrial loans tend to have more reliable deposit bases than banks that specialize in commercial real estate lending, Mr. McGratty says. That is because the companies that borrow from C&I lenders tend to keep deposit balances with the banks for working capital needs, while real estate borrowers put the money to work right away on new projects.

New York Community Bank, for instance, which specializes in multifamily real estate lending, had a deposit beta of 36% in the third quarter, according to KBW, showing that it is paying up for deposits. Large regional C&I lender Comerica , by contrast, had a deposit beta of just 14%.

Real-estate loans tend to be fixed-rate, while commercial and industrial loans have floating rates, making them more attractive when rates are rising. This helps explain why New York Community Bank shares are down 20% so far this year, while Comercia shares have risen 16%.

Bank-deposit costs may get more in sync as rates keep going higher, but for now investors need to focus on the differences.

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