Deposits are front and center right now for most banks. Over the last year, the Federal Reserve has raised its benchmark overnight lending rate, the federal funds rate, above 4.5%, putting many banks in uncharted waters.
Deposit costs, which rise on a lag, started to move up significantly in the fourth quarter and are expected to continue to see pressure in the quarters ahead. The Fed is also pulling liquidity out of the economy through quantitative tightening, which is draining deposits from the banking system. Banks have seen large deposit outflows, largely in lower-cost deposit products.
The large regional lender KeyCorp (KEY 1.43%) has so far outperformed most of its regional peer group on deposit costs, which could be a material advantage if it can continue to do so this year.
Comparing deposit betas
Deposits are important for banks because they fund interest-earning assets such as loans. The more cheaply you can fund those assets, the more money you make on loans and securities. But when deposit costs rise, bank margins get compressed.
There are lots of ways bank management teams analyze their deposit base, but an easy one for retail investors is by looking at their deposit beta among interest-bearing deposits. The deposit beta looks at how much a bank increased the interest it pays on deposits in response to an increase in the federal funds rate. So, if the Fed raises interest rates by 0.75 percentage points and a bank's deposit costs rise by 0.15 percentage points, then the deposit beta is 20% (0.15/0.75).
Let's take a look at how deposit betas held up in 2022 at KeyCorp compared to its large regional bank peers. I'll also look at the decline each bank saw in non-interest-bearing deposits, which are those the bank pays no interest on. Keep in mind that the federal funds rate at the end of 2022 was inside a range of 4.25% and 4.5%, so I'm going to use 4.25% when calculating the beta.
| Bank | Interest-bearing deposit costs 12/31/2021 | Interest-bearing deposit costs 12/31/2022 | Deposit beta 2022 | Change in non-interest-bearing deposits 2022 |
|---|---|---|---|---|
| KeyCorp | 0.06% | 0.74% | 16% | (10.7%) |
| U.S. Bancorp | 0.10% | 1.18% | 25.4% | (12.5%) |
| Truist Financial Corp (TFC -0.13%) | 0.42% | 0.06% | 8.5% | 4.5%* |
| PNC Financial | 0.04% | 1.07% | 24.2% | (14.7%) |
| Citizens Financial Group (CFG 1.57%) | 0.13% | 1.23% | 25.9% | 3%* |
| M&T Bank (MTB 0.75%) | 0.80% | 0.05% | 17.6% | 15%* |
| Fifth Third Bancorp | 0.04% | 1.05% | 23.7% | (15.8%) |
| Regions Financial (RF 2.17%) | 0.07% | 0.57% | 11.7% | (8.2%) |
Data source: Bank earnings reports, *=positive gain
As you can see in the chart above, KeyCorp had a lower deposit beta than everybody except Truist and Regions. Interestingly, there were also some banks that grew non-interest-bearing deposits in 2022, such as Truist, M&T, and Citizens. But keep in mind that both M&T and Citizens closed large acquisitions in 2022, which made them bigger.
Truist is the by-product of the large merger of equals between BB&T and SunTrust, which has required a lengthy integration process, so there could be some abnormal effect there. But Truist is also in very attractive banking markets that are seeing above-average population growth.
On KeyCorp's fourth-quarter earnings call, management said they are anticipating their deposit beta to peak in the mid- to high 20th percentile, which is well below the bank's historic deposit beta performance in rising interest rate cycles. Roughly 60% of KeyCorp's retail deposits are in stickier core consumer and escrow accounts, while 80% of the bank's commercial deposits are in operating accounts.
Truist is projecting its deposit beta to peak in the high 30s or low 40s percentage range by the Fed's last hike, while Regions is projecting a 35% beta by year-end.
This could be big for KeyCorp
Banks are operating in the unknown when it comes to the Fed's aggressive interest rate hikes and quantitative tightening, so anything can happen. KeyCorp's CEO Chris Gorman acknowledged that customer behavior has been very difficult for the bank to model when it comes to deposits.
But if KeyCorp is able to deliver on its deposit beta projections and outperform its peer group through the cycle, investors may look at the bank differently and reward it with a higher valuation. Currently, KeyCorp trades in the middle of the pack of its peer group when it comes to its price to tangible book value, or net worth, so there is certainly room for improvement.
