Bank Strategy – Rotation and the Deposit Debate

_{Source: Bloomberg}

_{Source: Bloomberg}

• The 2 charts are from mid-day yesterday post the Broadcom (AVGO) quarter and resulting washout in semis and “growth” writ large relative to the YTD performance of the top 11 GICS sectors. Regionals are up ~3% today as I write this on “no new news.” So has the driver of the recent underperformance been solely because of deposit pricing concerns or because of the narrowness of money flow into a very few sectors at the expense of poor financials? The answer (at least in my mind) is clearly both, but the magnitude and the sentiment shift felt a little like the fallacy of “Post Hoc Ergo Propter Hoc.” While deposit costs/mix shift are a legitimate headwind, maybe investors were letting the sector rotation drive a more negative view on the stocks than they deserved? I’ll leave it to the reader to decide, but it feels like it’s at least partially true.

Deposit Costs – The Elephant in the Room

• Setting the Jeb Bartlett Latin lesson aside, deposit mix shift is a legitimate concern and I think about the concerns in the buckets of shorter term vs. longer term headwinds.
  • On the longer-term front, I’m going to put stablecoin in that bucket. Given the turmoil amongst the Republicans post primaries, the lateness of the legislative session and the lobbying from the smaller banks represented by the ICBA, Kim Wallace tends to believe that Clarity Act enactment this year is unlikely. Given where Congress may be from a party in control standpoint come November, if it doesn’t make it into this legislative session, it could be 2028 before we have the next substantive legislative conversation.
  • Agentic AI would be the next concern which I’d put more in a “medium term” bucket. The thought process here is that an AI agent would optimize your idle non-IB deposits and/or deposits that are earning a below average rate into a higher yielding CD or money market account. That does make some sense to me, but from a practical perspective I believe adoption would take some time. In addition, while there may very well be an addressable market, I would tend to think that the “TAM” would tend to be high net worth/small to maybe medium size businesses. If the deposits are too granular or truly transactional based, the economics won’t make much sense. If the deposit base is too big/too sophisticated with a CFO/corporate treasurer, it’s likely that they’re already participating in some type of treasury sweep. It’s those in the “middle” where an AI Agent may have a true value proposition over time.
  • Over the near term, the H.8 data indicates that loan growth has remained strong with total loans up ~2.8% “quarterized,” total C&I loans up 5.1% but total deposits up ~1.4%. But within that deposit growth, non-time deposits are up only 0.6% while large time deposits are up 11.6% and borrowings are up 13.5% (all “quarterized”). In short, it’s this mix shift that has investors concerned. With the Fed now on hold, and the investment community used to following guidance on incremental/cumulative betas, we find ourselves working without a net so to speak on the rate of change in the absence of any movement in rates. So how do we crack the code on which banks are going to feel the deposit pressure soonest/most acutely? While not a straightforward exercise, we believe that individual business mix and growth strategy, along with the trends from Q2’24 to 1Q’26 can provide a window into the go forward. For the exhibits below, the observations we make set aside HBAN, FITB, and PNC where the data is skewed from their recent M&A. That said, let’s look at some of the non-M&A impacted names who spoke last week:
    
    • WFC (Sector Underperform) – Has been growing loans aggressively post asset cap removal predominantly C&I through the investment bank. They have also been growing their commercial deposits but as shown in the next few exhibits, deposit growth while strong has lagged loan growth. Given that much of that loan growth has been into the sponsor world where lending terms have likely been competitive and funded by commercial deposit growth, along with the fact that they have the lowest interest-bearing deposit beta and the 2^nd lowest cost of IB deposits, their guidance of additional sequential NIM compression makes sense. On the flip side, their capital markets update at Bernstein was a positive one and the stock has responded accordingly. From here, given their existing NII guide and the mix shift that’s happening, we would tend to think that dynamic (NIM headwind) should continue.
    • TFC (Sector Underperform) – was vocal at the Bernstein Conference regarding the NIM headwinds they are facing. We think a similar analogy to WFC holds with TFC as well. Like WFC, they have grown loans faster than deposits. Incremental deposit growth from here is more expensive than they would like given their commentary about wanting more non-IB deposits. They are also up against the headwind of forward starting swaps in 2H’26 which makes the path more difficult.
    • CFG (Sector Perform) – An interesting example of a number of nuances. Deposit growth over the cycle has exceeded loan growth thanks to rotating the loan book away from legacy Auto & Education loans to Home Equity & Private Bank loans. At the same time the Private Bank is bringing with it ~30-33% non-IB deposits relative to a base of ~22.5% with those Private Bank deposits on track to be $18bil-$20bil by year end. Combine the positive mix shifting that’s happening along with the tailwind from the swap abatement and we find ourselves above consensus for FY’26 & FY’27 NII. At Bernstein, management continued to endorse the Q and full year guide. While they did acknowledge that there had been a bit more deposit competition, their forecast did at least in part already take that into account.

To wrap up, last week provided some breadcrumbs on how to think about the space in this interim rate period. We continue to be positive on Regions Financial (high % NIB, CD reprice, fixed asset reprice) along with Fifth Third and US Bancorp while having underperforms on M&T, Truist & Wells Fargo. While we expect the deposit debate to continue, the sector as a whole has likely been a victim of broader rotation suggesting that perhaps the recent sentiment has been a bit overdone. We continue to remain constructive on the regional banks.

_{Source: S&P Global}

_{Source: S&P Global}

_{Source: S&P Global}