Funding costs for banks did not move much over two large interest rate hikes by the Federal Reserve in the second quarter, according to data from S&P Global Market Intelligence.

But after another big increase in late July, with more likely on the way, banks widely expect the pressure on deposit prices to ratchet higher.

"The starting point here is that we haven't seen a lot of pressure on deposit rates," said KeyCorp CFO Donald Kimble Jr. on the bank's earnings call. KeyCorp's cost of interest-bearing deposits rose just 2 basis points sequentially to 8 basis points.

Banks have been helped by the fact that half of the Fed's 150 basis points of rate increases in the first six months of the year came late in the period, on June 15. But with the 75 basis point increase on July 27 and market expectations for fed funds above 3% by the end of the year, "we'll start to see more customer changes and more competition for deposit rates going forward," Kimble said.

KeyCorp estimated that its deposit beta, or the change in deposit costs relative to underlying rates, was 3.5% to 4% in the second quarter and forecast that its incremental beta will move closer to 30% toward the end of 2022.

Still, banks like KeyCorp expect loan yields to continue to rise even faster and hope that their deposit franchises will distinguish them from competitors that have not had as much success capturing core relationships. Kimble said his bank has overhauled its deposit mix since the last hiking cycle and would have had a deposit beta of about 40% to 45% historically.

Low betas so far

Across the 15 largest publicly traded U.S. banks, the median cost of interest-bearing deposits was up just 8 basis points sequentially and 5 basis points year over year to 12 basis points in the second quarter.

These deposits exclude non-interest-bearing deposits, which make up 19% to 61% of each of the banks total deposits, and do not give a full picture of funding costs.

Overall net interest margins were up at every member of the group, with the median NIM increasing 21 basis points sequentially and 24 basis points year over year to 2.66%.

Analysts at Janney Montgomery Scott calculated that 80% of about 270 banks for which data was available as of July 29 posted deposit betas of 10% or less.

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Outflows

Some runoff of the pandemic surge in deposits did surface in the second quarter.

Deposits fell 2.1% across the big bank group sequentially, a bit ahead of the 1.5% decline for the industry as a whole from March 30 to June 29 according to weekly Fed data. A number of banks cited pressure from clients paying unusually large tax bills during a period that is typically soft for deposit growth — seasonally adjusted figures from the Fed showed deposits down just 0.1%.

Banks like Regions Financial Corp. still expect substantial outflows of rate-sensitive deposits. But other banks like Bank of America Corp. and Citigroup Inc., despite their concentration in wholesale deposits, continue to expect deposit growth this year.

Industrywide deposit declines over about a year of full-speed quantitative tightening — the name for the Fed's reduction of bond holdings it accumulated to stimulate the economy — are unlikely, according to a June analysis by rates strategists at BofA Global Research. Assuming a $1.14 trillion reduction in the Fed's balance sheet over 12 months, with 75% coming from bank reserves and the rest from a program used by money market funds, nominal GDP growth would have to fall to 4% or below to fully offset customary increases in the money supply. Real economic growth has been soft but inflation has been elevated.

The weekly Fed data gives an early read on deposit trends in the third quarter, with industrywide deposits down 0.4% from June 29 to July 20, or about flat after seasonal adjustment. Some of the relative stability appears to reflect a shift toward higher-cost funding, however. Large-time deposits, which often carry higher rates, were up 2.3% over the three weeks, or 2.8% after seasonal adjustment.