Fed’s Growth Restriction On Wells Fargo Helped Boost The Bank’s Loan-To-Deposit Ratio In Q2

The loan-to-deposit ratio (LDR) for the largest U.S. banks continued the upward trend they began early this year for the second quarter, thanks to the favorable combination of an improvement in lending activity and a reduction in the deposit growth rate. While lending activity has received a boost over the last few months from an upbeat outlook for the U.S. economy, the improving interest-rate environment has resulted in customers moving their cash from bank deposits to other investment options offering better yields.

Notably, Wells Fargo stands out with an improvement in its LDR figure of nearly 100 basis points (1% point) between Q1 2018 and Q2 2018. In comparison, the bank with the second-largest improvement in its LDR (JPMorgan Chase) reported gains of just over 20 basis points (0.2% point). Ironically, the sharp improvement in this key profitability metric for Wells Fargo is a side effect of the growth restriction imposed by the Fed on the bank. This is because the Fed’s enforcement order forced the troubled banking giant to liquidate a sizable chunk of non-core deposits to make room for organic growth in its business over subsequent quarters. This resulted in the LDR figure jumping over Q2 despite Wells Fargo’s steadily shrinking loan portfolio. Incidentally, this also played a role in Wells Fargo’s upbeat net interest margin (NIM) figure for Q2.

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.

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%. U.S. Bancorp clearly fares the best in this regard.

It can be seen here that the largest U.S. banks saw their LDR figure slide over 2017 despite an overall improvement in this metric for the U.S. banking industry. This discrepancy can be attributed to the fact that customers shifted their savings from smaller banks and credit unions to the country’s largest banks – leading to an above-average deposit growth for these banks, and dragging down their loan-to-deposit ratios. However, the overall improvement over the last two quarters appears to indicate that LDR growth for the largest U.S. banks is finally catching up with their smaller peers.

This is good news, as loans in the U.S. should continue to outpace deposits over coming years – driving the LDR figure, and consequently their net interest margins (NIM), higher going forward. While Wells Fargo is unlikely to fully realize the benefits of this trend until it manages to get the Fed’s clearance to grow its balance sheet, the bank should still see small improvements in its profit margins in the near future.

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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