KBRA Financial Intelligence

Coming Fed Easing May Finally Allay Banks’ Funding Crunch

SEP 5, 2024, 2:00 PM UTC

By KFI Staff

Welcome to the KFI Monthly Insights. KFI Insights is now spearheaded by Sean McGovern, Associate Director, who brings more than seven years of expertise in financial research and thematic analysis across various sectors. In this edition, we highlight the following key topics:

Divergence between the U.S. Treasury yield curve gauges
Deposits decline in 2Q 2024, and upcoming interest rate cuts that will lower the cost of holding interest-bearing deposits
Mergers and acquisitions (M&A) activity among U.S. lenders, which is showing signs of rebound after the slowest year in recent history

A Tale of Two Yield Curves

Though some segments of the U.S. Treasury yield curve have experienced a steepening, rates at the shortest end of the curve have remained particularly elevated. For instance, the spread between rates on the 10-year and two-year maturities (T10Y2Y) reached its narrowest level in two years earlier this month, briefly escaping inversion territory on August 7. This is the mirror opposite of what is occurring in the spread between the 10-year and three-month (T10Y3M) Treasury yields, which fell back into its deepest inversion since January in the week ended August 23. Such a divergence indicates that the inversion of the T10Y3M spread has never been so wide relative to the T10Y2Y spread, recently reaching the equivalent of more than 130 basis points (bps).

Divergence Between U.S. Treasury Yield Curve Gauges

As this figure shows, although rates on medium- and long-term Treasury maturities have been falling, likely due to bond traders front-running expected Fed rate cuts, the nearest portion of the curve remains elevated and will not budge much until the central bank begins cutting rates. Though rate cuts may often present a threatening prospect for banking income, the ongoing asymmetrical decline in rates has anticipated these cuts for some time, diminishing what banks charge for longer dated lending while short-term funding remains relatively expensive. That has foisted sustained stress on banks’ loan margins in the interim. In this case, it is likely that the realization of rate cuts could be a welcome development for banks that will be able to access cheaper deposit inflows. Our team highlighted persistent pressure on banks’ net interest margins (NIMs) in our June edition of KFI Insights, exemplifying ongoing compression in loan profitability.

Deposits Drawn Down in Q2

Deposit growth has been continually subdued while alternatives like T-bills and money market funds remain lucrative. Reviving deposit inflows has been a key goal among American financial institutions since withdrawals of nearly $1 trillion in deposits between March 2022 and May 2023 played a key role in setting off the sequential collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank last year. These incidents represented three of the four largest American bank failures in history. Throughout 2Q 2024, total deposits held by all U.S. commercial banks declined by $200 billion, equivalent to a 1.05% quarter-over-quarter (QoQ) reduction. That marked the largest collective QoQ deposit outflow since the first of the bank failures kicked off in 1Q 2023. Among the five cohorts of U.S. banks in the table below, depositories with $1 billion to $10 billion in assets were the only grouping that managed to increase their collective holdings, adding a net $18 billion in deposits. KFI Pro subscribers can review bank deposit data by using KCALLTD in the Excel add-in tool.

Keeping banking products competitive in terms of yield while protecting profit margins has been difficult for many depositories. The average cost of interest-bearing deposits among banks in our sample—calculated as the interest expense from deposits relative to interest-bearing deposits—was 2.6% in 2Q 2024, up 89 bps from the same period in the year prior. KFI Pro subscribers can dive deeper into this metric by utilizing KCALLCIBD in their Excel templates.

Light at the End of the Tunnel

Plotting the cost of interest-bearing deposits against the ratio of banks’ interest-bearing deposits to total deposits can help to identify the banks that could be most palpably impacted by an ability to charge lower rates on deposits in the future. In particular, banks that maintain very few non-interest-bearing deposit accounts—such as Goldman Sachs, Morgan Stanley, UBS, and Capital One—stick out as those set to benefit from lower rates. The average ratio of interest-bearing deposits to total deposits among U.S. commercial banks was 77.18% in 2Q 2024. KFI figures show a positive correlation between the proportion of banks’ interest-paying deposits and the rate they pay on them.

Interest-Exposed Deposits Ratio vs. Cost of Interest-Bearing Deposits - 2Q24

One of the most notable outliers in this data is Deutsche Bank Trust Co. Americas (KFI Score: A), the primary commercial bank subsidiary of Deutsche Bank in the U.S. Though Deutsche Bank is currently paying the highest rate on interest-bearing deposits at 6.72%, leading second-place Hatch Bank (KFI Score: A) by a wide margin of 132 bps, it only pays interest on 61.91% of its $28 billion of deposits. That is the sixth-lowest percentage among peers with total assets in the $10 billion to $100 billion range.

Fed Chair Jerome Powell all but confirmed rate cuts were imminent in his speech at the Jackson Hole Economic Symposium last week, stating that “the time has come for policy to adjust.” This turning point suggests that some of the headwinds facing the funding side of the loan book observed in Q2 may be set to subside.

Recent M&A

Mutual Federal Bank (KFI Score: B-), a $95 million lender in Chicago, announced a merger with Pulaski Savings Bank (KFI Score: B-), a $49 million lender in Chicago, for an undisclosed price, according to an August 30 press release. The deal is expected to close in 1Q 2025.

Bridgewater Bancshares, Inc. (NASDAQ: BWB) (KFI Score: B), a $4.7 billion lender in St. Louis Park, Minnesota, announced an agreement to purchase First Minnetonka City Bank (KFI Score: B+), a $242 million lender in Minnetonka, Minnesota, in an all-cash transaction. The deal is expected to close in 4Q 2024, according to an August 28 press release.

First Busey Corporation (NASDAQ: BUSE) (KFI Score: B+), a $11.9 billion lender in Champaign, Illinois, announced a merger with CrossFirst Bankshares, Inc. (NASDAQ: CFB) (KFI Score: C+), a $7.6 billion lender in Leawood, Kansas, for approximately $917 million in an all-stock deal. The merger is expected to close in 2Q 2025, according to an August 27 press release.

Old Second Bancorp, Inc. (NASDAQ: OSBC) (KFI Score: B), a $5.7 billion lender in Aurora, Illinois, announced that its bank subsidiary, Old Second National Bank (KFI Score: B), will purchase five Illinois branch locations from First Merchants Bank (KFI Score: B-), the bank subsidiary of the $18.3 billion lender, First Merchants Corporation (NASDAQ: FRME) (KFI Score: B). Old Second will pay a deposit premium of 7.5%, or approximately $23 million, in estimated cash consideration to First Merchants. The deal is expected to close near year-end 2024, according to an August 27 press release.

Cornerstone Bank (KFI Score: B), a $2.8 billion lender in York, Nebraska, announced an agreement to purchase Bank of Orchard (KFI Score: B-), a $35 million lender in Orchard, Nebraska, for an undisclosed price, according to an August 21 press release. The deal is expected to close in 4Q 2024.

U.S. Eagle Federal Credit Union (KFI Score: B), a $1.5 billion lender in Albuquerque, New Mexico, announced an agreement to purchase Southwest Capital Bank (KFI Score: B-), the $475 million lender in Albuquerque, New Mexico, for an undisclosed price according to an August 16 press release. The deal is expected to close in 2Q 2025. This marks the 14th whole-bank purchase by a credit union so far in 2024.

The State Bank and Trust Company (KFI Score: B), a $1.3 billion lender in Defiance, Ohio, announced an agreement to purchase Marblehead Bank (KFI Score: B), a $267 million lender in Marblehead, Massachusetts, for approximately $5 million in cash, according to an August 14 press release. The deal is expected to close in 4Q 2024.

Spokane Teachers Credit Union (KFI Score: B), a $5.9 billion lender in Liberty Lake, Washington, announced an agreement to purchase Community Bank (KFI Score: B+), a $550 million lender in Joseph, Oregon, for an undisclosed price, according to an August 13 press release. The deal is expected to close in early 2025.

Bennington State Bank (KFI Score: B+), a $977 million lender in Salina, Kansas, announced an agreement to purchase Alliance Bank (KFI Score: B+), a $149 million lender in Topeka, Kansas, for an undisclosed price, according to an August 13 press release. The deal is expected to close in 4Q 2024.

Security Bank and Trust Company (KFI Score: B), a $1.2 billion lender in Paris, Tennessee, announced an agreement to purchase Bank of Ripley (KFI Score: B+), a $273 million lender in Ripley, Tennessee, for an undisclosed price, according to an August 5 press release. The deal is expected to close in 4Q 2024.

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