Erste Group's Q4 2023 earnings call was a symphony of record-breaking highs. Record NII, record fees, record low risk costs, and yes, even record expenses. The bank is riding a wave of exceptional performance, fueled by a historically favorable interest rate environment. But lurking beneath the surface of these celebratory pronouncements, there's a subtle, almost whispered concern about the future – a concern tied to the seemingly innocuous performance of the Czech NII.

While the bank's consolidated NII is projected to decline by a modest 3% in 2024, a closer examination of the Czech Republic reveals a potentially alarming trend. The Czech NII expanded nicely in Q4 2023, defying the impact of the discontinued remuneration of minimum reserves by the Czech National Bank. This growth, as Stefan Dörfler, the CFO, explained, was driven by a halt in the migration from current to term accounts.

This seemingly positive development raises a critical question: is this halt a sign of customer complacency or a harbinger of things to come across the entire Erste Group in 2025?

The bank's 2024 NII projection heavily relies on continued "terming out" of deposits, particularly in Austria. This assumption is based on the expectation that Austrian customers will continue to shift funds from current to higher-yielding term accounts, even as the ECB embarks on a rate-cutting cycle. This dynamic is expected to partially offset the NII pressure from falling interest rates.

But the Czech experience casts a shadow of doubt over this assumption. If Czech customers, already accustomed to rate cuts, are no longer responding with a shift to term deposits, what guarantee exists that Austrian customers will behave any differently when faced with the same scenario in 2025?

This is where the Czech NII becomes the canary in the coal mine. It's a microcosm of what may transpire across Erste Group's euro-denominated NII in 2025. Should the terming out dynamic falter, the bank's NII decline in 2025 could be significantly steeper than currently anticipated, potentially jeopardizing its ability to maintain the double-digit ROTE growth investors have come to expect.

Why This Matters

Firstly, Erste Group's sensitivity to euro rate cuts is substantial. The bank estimates a €300 million NII impact for every 100 basis point cut in euro rates, with a third of this impact originating from the savings banks segment. As the ECB embarks on a rate-cutting journey, this sensitivity will become increasingly relevant.

Secondly, the terming out dynamic, while favorable in the short term, has a finite lifespan. Once customers have adjusted their deposit mix, the NII uplift from this phenomenon disappears, leaving the bank exposed to the full brunt of falling interest rates.

The Czech NII stabilization, in the context of ongoing rate cuts, suggests this terming out limit may be closer than anticipated, especially when considering the granularity of the Austrian deposit base. Austrian customers, holding larger balances, are inherently more inclined to seek out higher-yielding alternatives, making a swift shift to term deposits plausible in the short term. However, this same granularity also implies a swifter exhaustion of the terming out potential, leaving the bank vulnerable to a more pronounced NII decline in 2025.

The bank's management, acknowledging the uncertain terrain ahead, has wisely refrained from providing a concrete NII outlook for 2025. But the Czech NII, in its quiet defiance of market expectations, provides a crucial early warning signal, prompting investors to scrutinize the sustainability of the terming out assumption and its implications for Erste Group's long-term profitability.

Hypotheses:

**Current account to term deposit shift in Austria:** The current projection for 2024 assumes a continued shift. If this shift stalls in 2025, mirroring the Czech Republic, NII decline could accelerate.

**Magnitude of ECB rate cuts:** A more aggressive rate-cutting cycle by the ECB than currently anticipated would amplify the negative NII impact, potentially leading to an NII decline exceeding 3% in 2025.

Numbers:

€300 million: Estimated NII sensitivity for every 100 basis point cut in euro rates (across entire group).

€100 million (approx): Estimated NII sensitivity per 100 basis point cut for the Savings Banks segment.

Projected Interest Rate Changes in 2024

The following chart displays Erste Group's projected interest rates for key currencies in their operating regions.

The Czech NII isn't just a data point, it's a story unfolding – a story that may foreshadow a more turbulent chapter for Erste Group's profitability in 2025. The question is, will investors heed the canary's warning?

"Fun Fact: The term "canary in a coal mine" originates from the practice of using canaries to detect dangerous levels of carbon monoxide in coal mines. The birds, being more sensitive to the gas than humans, would show signs of distress or die before miners were affected, providing a crucial early warning system."