New York | In the most recent edition of The IRA Bank Book, we note that the rate of increase in funding costs for US banks in 2018 was a bit over 70% year-over year. The rate of change in this key component of bank earnings is not particularly correlated to the broad swings in market interest rates and, by implication, investor confidence. But the normalization of bank funding costs is relentless. As we describe in some detail in the IRA Bank Book for Q1 2019, rising bank interest expense is a structural trend that heralds the end of extraordinary monetary policy, at least for now.
Whereas the quarterly cost of funding for all US commercial banks was just shy of $40 billion at the end of 2018, by the end of 2019 funding costs for the $17 trillion in US bank assets should be closer to $70 billion, especially for the larger banks. Asset earnings are rising at one quarter of the rate of funding expenses, BTW, the result of a continued sellers market in collateralized loan obligations (CLOs) and straight debt. At year end 2018, the average cost of funds was well over 1.3% for large banks such as Citigroup (1.27% Q4’18) but the average for the top 100 banks is still below 1%.
Despite the full stop retreat by the Federal Open Market Committee, the impact on the bank earnings is likely to be negative, albeit gradually. The fact of a flat yield curve and continued downward pressure on yields for loans and securities is not particularly helpful when it comes to keeping asset returns even with increase funding costs.
The chart below shows our projections for bank interest income and expense from Q1 2019 through Q4 2019. Note that we see net interest income stop growing in Q1’19 and begin to shrink in dollar terms as the year continues. We currently project that US bank funding costs will exceed $70 billion per quarter by year-end 2019.