Well, it finally happened. After increasing short-term policy rates at the fastest pace in modern history and holding them there for more than a year, the Federal Reserve reduced the federal funds rate by 50 basis points (0.50%) in September to kick off an eagerly anticipated rate-cut cycle. According to the FDIC, community bank net interest margin (NIM) rose by seven basis points in the second quarter of 2024, but profitability pressures clearly remain. Both return on assets (ROA) of 0.95% and return on equity (ROE) of 9.60% increased only modestly versus the previous quarter. Given the liability sensitivity exhibited by the industry over the past year and a half, one might think that the directional change in short-term policy rates — and an associated re-steepening of the yield curve — might be a boon for bank profitability. However, there are a couple of reasons this may not be the case. Takeaways From Previous Cycles Though a steeper yield curve is better for bank profitability over the medium to long term, asset yields may be more responsive to reduced policy rates than liability costs in the near term. This seems somewhat counterintuitive but is primarily driven by two factors. The first is that a greater percentage of assets than liabilities are indexed. That means that once the index declines, coupons reset lower at the next reset date. What’s considered a boon when interest rates rise will work in reverse as rates decline. Second is the migration of non-maturity deposits into CDs. While most CDs feature relatively short tenures, this movement lengthens the average maturity of liabilities and will limit banks’ ability to reduce deposit rates in lockstep with policy rates. This delay is amplified for institutions in competitive markets, as your ability to lower deposit rates may BRIDGING THE GAP Rate Cuts Could Hit Your Margin, But There Are Steps You Can Take to Reduce the Pressure BY MICHAEL BENEDICT, MANAGING DIRECTOR, FIXED INCOME STRATEGIES, STIFEL PORTFOLIO MANAGEMENT 10 In Touch
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