KeyCorp's (KEY 0.62%) stock has dropped by nearly a third so far in 2023. The vast majority of that fall was related to the banking crisis early in the year, when a number of regional banks faced runs that put them out of business. KeyCorp has held up fairly well, with deposits down just 3.1% year over year in the second quarter. But there's more to this story than total deposits.
KeyCorp's business is in the spread
Modern banks are complex, but the core of the business is fairly simple to understand. KeyCorp takes in deposits from customers and then lends the cash out to other customers. It pays depositors interest for the cash they keep with it. It charges borrowers interest for the loans it makes to them. The bank's profit is the difference between the interest it charges and the interest it pays. Again, that's a simplification, but it gets to the core of the story.
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Here's the thing: KeyCorp doesn't really control the interest rate it charges or the rate it pays. Sure, it could charge and pay wherever it liked, but if the numbers were out of line with the rest of the banking market, its business would dry up quickly. Customers would simply vote with their feet and switch banks. Thus, KeyCorp has no choice but to remain competitive and match the prevailing interest rates.
These rates are driven heavily by the Federal Reserve, which raises and lowers rates to help control economic activity. Right now, the Fed is worried about rapid inflation and is trying to cool the economy off. It's increasing rates at a fairly rapid clip. That's changing the playing field in a big way for Keycorp.
The various important numbers under deposits
Deposits make up the top-level figure. What's happening beneath that number is more telling. Specifically, non-time deposits -- things like bank and checking accounts -- fell 3.9% from the first quarter and 11.3% from the second quarter of 2022. These types of accounts generally offer lower interest to customers.
Large CDs and other time deposits, meanwhile, saw material growth. The number of CDs worth $100,000 or more jumped 61% sequentially and 159% year over year. Other time deposits increased by 40.2% from the first quarter and a whopping 476.3% from the second stanza of 2022. Time deposits generally offer higher rates to customers than bank and checking accounts do.
What you're seeing is a shift in the mix toward products with higher interest. That makes complete sense given the rising rate environment. When rates were near historical lows, there was no point moving money around, since rates weren't meaningful in any product. But with higher rates, that situation has changed. And it's having a huge impact on KeyCorp's business.
The company's cost of deposits is the next number that shows this change. It's important because deposits are among the cheapest cash sources for a bank. In the second quarter of 2022, cost of deposits was a tiny 0.06%. By the first quarter of 2023, the figure had risen to 0.99%. And in the second quarter of the year it was 1.49%. On an absolute basis, these numbers are still fairly modest and the change wasn't all that outlandish. But year over year, KeyCorp is now paying nearly 25 times the interest it was in the second quarter of 2022. That's a swift and shocking turn.
The banking industry is in a state of flux
There are two important takeaways here. First, despite the headwinds, KeyCorp is holding its own in a very difficult market. Customers are leaving, but it doesn't seem the rate is fast enough to result in the bank's failure. That's good news. However, rising rates are changing the way customers bank, and KeyCorp has to adjust accordingly. That's leading to important shifts in its business that are increasing its costs. Shareholders need to make sure they keep a close eye on these more subtle changes as they monitor this regional bank stock.
