Largest U.S. Banks Should Gain Considerably Over Coming Months From Improving Loan-to-Deposit Ratios

The loan-to-deposit ratios for the largest U.S. banks finally bucked the trend of steady declines seen since 2011 to nudge higher in Q1 of this year. Taken together with the hawkish outlook for benchmark interest rates by the the Fed, the improving LDR figure is great news for the U.S. banking giants, as it should help their interest revenues grow at a much faster rate than interest expenses over subsequent quarters. Notably, while the LDR for the U.S. banking industry as a whole has trended higher for several quarters now, the largest U.S. banks had not benefited from this as their deposit bases grew at a faster rate than loans.

We capture the trends in loans and deposits for each of the five largest commercial banks in the country – JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, U.S. Bancorp – through interactive dashboards, while also detailing the impact of changes in these key factors on their valuations.

The LDR ratios for the five largest U.S. banks range from around 65% for JPMorgan Chase and Citigroup to almost 85% for U.S. Bancorp. The significantly diversified business models for JPMorgan and Citigroup (both of which have large custody banking divisions) are primarily responsible for their relatively low LDR figures, while U.S. Bancorp’s traditional loans-and-deposits business model explains its higher LDR figure. Notably, Bank of America stands out here with its LDR remaining under pressure in Q1 2018 – something that can be attributed to the ongoing run-off in its legacy mortgage portfolio.

The table below captures the changes in LDRs for these banks over the last five quarters and is based on numbers reported by these banks in their quarterly SEC filings. The average figure for the top 5 banks is obtained by taking the ratio of the total loans across these banks with the total deposits for these banks. The figures for the U.S. banking industry are obtained using the weekly loans and deposits data compiled by the Federal Reserve.

The loan-to-deposit ratio is the ratio of a bank’s total outstanding loans for a period to its total deposit balance over the same period. So an LDR figure of 100% indicates that a bank lends a dollar to customers for every dollar that it brings in as deposits. But this also means that the bank doesn’t have significant cash on hand for contingencies. A combination of prudence and regulatory requirements suggests that for a traditional bank, the LDR should be around 80-90%.

With a business model that relies heavily on traditional loans-and-deposits services, U.S. Bancorp has an LDR figure that appears to be optimal. As for the other banks, the ratio seems to be inversely proportional to the degree of diversification in the business model – the more diversified the bank in terms of offerings, the lower the LDR figure. Understandably, U.S. Bancorp’s profits stand to gain the most from the ongoing trend of improving LDR and higher interest margins.

The Fed’s ongoing rate hike process has had a positive impact on the interest rate environment over recent years. And as better investment options became available to individuals as well as institutions, it helped deposits grow at a slower rate than what was seen over 2011-2016. However, the largest U.S. banks continued to witness above-average deposit growth over 2017 as customers shifted their savings from smaller banks and credit unions to the country’s largest banks – something that weighed on their loan-to-deposit ratios. With the LDR figure finally trending upward in Q1, the U.S. banking environment seems to have normalized.

This would imply that the loan portfolio for the largest banks is likely to grow at a faster rate than deposits in the future. This, in turn, will amplify the impact of subsequent rate hikes on the net interest margin (NIM) figure of these banks. As gains to net interest income accrue largely to the bottom line, this points to improved profits for the largest banks going forward.

Details about how changes to key Loan and Deposit parameters affect the share price of the five largest U.S. commercial banks can be found in our interactive model for JPMorgan Chase | Bank of America | Wells Fargo | Citigroup | U.S. Bancorp

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