The end of the Federal Reserve's rate-hiking campaign may be near, but funding pain for banks is only intensifying as deposit prices catch up and the industry prepares for more outflows this year.

U.S. banking deposits fell $166.38 billion sequentially in the fourth quarter of 2022, according to data from S&P Global Market Intelligence, and that drain has continued so far in 2023, weekly data from the Fed shows.

Mounting pressure on deposit costs has prompted analysts to mark down projections for net interest income. After the loose-money era that prevailed early in the pandemic, the reversal is uncovering vulnerabilities in deposit franchises as some banks have been forced to make sharp swings toward wholesale funds and expensive certificates of deposit.

Banks, at first, shrugged off the outflows as they had more deposits than they needed, according to Adam Stockton, director of retail deposits at Curinos. Then they opted to raise deposit rates a bit, assuming that would stem the tide, but the outflows continued.

"So now it's 'What can we do? Is anything going to work?'" Stockton said.

Delayed not avoided

More than half of the 99 basis-point increase in banks' cost of funds across the cycle hit them in the final three months of 2022, according to the S&P Global Market Intelligence data. But even if the Fed's target interest rate hits a plateau in the coming months, banks and analysts expect substantial further increases in deposit costs.

"The question is really about lags," JPMorgan Chase & Co. CFO Jeremy Barnum said at a conference on Feb. 14, adding that the long repricing intervals seen thus far make sense because underlying interest rates have moved so quickly. "From our perspective, it's just common sense to expect that to catch up more or less independently of what happens with the Fed."

In the first half of 2019 — after the Fed's last rate increase in the previous cycle, and with widespread expectations that the next move would be a cut — commercial depositors that "were late to the party" still secured higher rates, said Peter Serene, director of commercial banking at Curinos, a consulting and data firm.

"They repriced from 25 basis points to 125 basis points all at once," Serene said. "Even though it was only the 10% or 20% of laggards who hadn't called their banker yet, because they repriced so much so late in the cycle, it really pushed the overall ... cost of funds for the banks higher quickly."

About 23% of money market deposits held by commercial middle market customers are still priced below 75 basis points, according to Serene, leaving a "lot of pent-up risk for banks."

Commercial deposit betas from the start of the current cycle through the end of 2022 are already on par with the last full cycle, the director added.

"Given the runway that we still have, they're going to be higher on a through-the-cycle basis," Serene said.

Betas are the ratio of the move in deposit costs relative to underlying rates.

On the consumer side, banks have been helped by factors like a lower starting point relative to the last cycle, Stockton said, and Curinos expects a lower through-the-cycle beta.

Banks' total cost of funds was 0.15% in the fourth quarter of 2021, according to S&P Global Market Intelligence data, about half of the 0.31% in the third quarter of 2015, before the start of the previous hiking cycle.

"There's been a pretty marked shift towards a desire to use rate more aggressively to keep deposits, particularly at the larger banks on the retail side over the last two to four months," Stockton said. "But given how much of the portfolio is still priced at zero, the overall portfolio betas still look favorable."

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Balance trends 'still really negative' for 2023

In addition to three consecutive quarters of overall deposit outflows, banks have also experienced a quick rebound in higher-cost accounts.

CD balances represented 9.6% of the total in the fourth quarter of 2022, up from a low of 6.8% in the first quarter of that year and the highest point since the third quarter of 2020. That includes a 22.4% sequential increase during the last three months of 2022 for time deposits in accounts with balances of less than $250,000, indicating a scramble to hold onto yield-seeking retail money.

The potential for further overall deposit outflows now depends on the "old equation" between loan growth, which adds money to the system, and the Fed's program to shrink its balance sheet as it tightens monetary policy, Barnum said. JPMorgan Chase expects "modest declines" in both consumer and wholesale deposits.

Stockton anticipates further aggregate outflows on the consumer side before trends start to get better at the end of 2023, with an additional transfer from more traditional banks to online banks that have competed aggressively on rate.

While in the commercial arena the "hottest money" has already left, Serene said he expects substantial further runoff in 2023, with much depending on a highly uncertain economic outlook.

"So a little less painful, but still really negative," Serene said.