Interest rates' remaining elevated is producing crosscurrents for bank net interest margins.

Pushed out rate cuts are delaying prospects for declines in funding costs even as banks trim rates on their highest-cost offerings and upward cost pressure on deposit portfolios overall peters out. At the same time, derivatives that banks use on variable-rate loans to protect against potential rate declines are limiting the upside on higher loan yields.

Deposit pressures ease

Those dynamics were reflected in first-quarter cumulative betas, which measure the sensitivity of deposit portfolio costs and loan portfolio yields to movements in underlying interest rates since the Federal Reserve started tightening monetary policy in early 2022, according to data from S&P Global Market Intelligence. At the median bank in the US, the cumulative deposit beta increased 2.92 percentage points sequentially to 29.62% in the first quarter, less than the sequential increase of 4.07 percentage points recorded in the fourth quarter of 2023 and 5.78 percentage points in the first quarter of 2023, when numerous banks experienced acute deposit outflows amid two large failures.

Meanwhile, the sequential change in the cumulative loan beta was just 1.48 percentage points to 22.05%, less than the sequential change of 3.17 percentage points in the fourth quarter of 2023. Combined, the sequential decline in the median net interest margin (NIM) accelerated to 7 basis points in the first quarter from 1 basis point in the fourth quarter of 2023.

Many banks have forecast that their net interest income (NII) has bottomed or will bottom soon as deposit pressures have eased and as large pools of fixed-rate assets reprice. They could face new headwinds at the start of cutting cycle, however.

"Bank margins are likely to contract following a Fed cut [with] assets likely [to] reprice faster than deposits," like they did at the beginning of the tightening cycle and NIMs expanded, BofA Global Research analyst Ebrahim Poonawala said in a June 3 note, though "margins should stabilize as we near an end to rate-cuts," thanks to loan growth and a more favorable rate curve.

Stunted yields

In the aggregate, the cumulative loan beta, as opposed to the median, actually contracted 0.44 percentage points to 49.99% as the industrywide loan yield ticked down 3 basis points sequentially to 6.91%.

Overall yields can reflect shifts in the mix of loans, with credit card lending, which is generally high interest rate, seasonally soft in the first quarter. Commercial and industrial lending, which similarly tends to be variable rate, has also been weak. Banks have reported that customers are reluctant to borrow against credit lines when rates are high.

Hedging activity through which banks swap variable-rate interest payments on loans for fixed-rate payments has also been crimping NIMs, according to analysts at Jefferies.

"Impacts from hedges were a large headwind to NII in 2023 and [the first quarter of 2024] given the rapid rise in rates, which pushed receive-fixed rate hedges on loans and long-term debt deeply into negative territory," they said in a May 22 analysis.

However, the Jefferies analysts also estimated that "incremental quarterly NII pressure has peaked for most and will hold steady until the Fed begins to cut rates."

Banks including KeyCorp and Citizens Financial Group Inc. have emphasized potentially large lifts as swaps mature and run off. In its first-quarter earnings report, Citizens Financial estimated that a drag of about 65 basis points on its NIM from receive-fixed swaps and a noncore portfolio of low-yielding consumer loans would diminish to a drag of about 36 basis points in the fourth quarter of 2025, assuming Fed cuts. Its weighted average receive-fixed rate as of March 31 was 3.7% in the first quarter and 3.1% for the rest of the year.

Painting with different brushes

How shifts in the rate environment impact individual banks will vary widely based on balance sheet positioning and business models.

Beta performance tends to be stable across cycles. For example, banks with the highest, or worst, cumulative deposit betas in a tightening cycle also tend to have had high deposit betas during the most recent easing cycle, so they are particularly poised to benefit from funding cost relief if rate cuts materialize. In some cases, high deposit betas are paired with high loan betas, creating offsetting impacts for companies such as American Express Co. and Synchrony Financial that focus on credit cards and collect deposits online.

JPMorgan Chase & Co., the largest bank in the country, gave guidance in May that it expects both sequential increases and sequential declines in net interest income over the next six quarters.

Despite Poonawala's expectation that rate cuts would hurt bank earnings in general over the near term, the analyst maintained a favorable view on the sector overall. Gradual rate cuts of about 25 basis points per quarter "should be manageable," he said.

"Lower rates should also provide support to a more constructive outlook" on factors including credit quality, where higher debt service burdens can strain borrowers, Poonawala added.