By John Hintze
The pandemic’s crisis phase may be in the rearview mirror, but bank balance sheets may have caught a case of long COVID. Banks still face enormous balance sheet challenges that are squeezing margins. While asset generation has picked up moderately, loan rates have lagged this year’s rapid rise in interest rates, so proactive banks are turning to deposit liabilities that, while still at historically high levels, can be managed ever-more effectively.
The numbers clearly illustrate banks’ challenges. Federal Reserve data shows deposits exceeded loans by $6.6 trillion at the end of June, down from a high of nearly $7.4 trillion last December but still much more than the $3.2 trillion range in early 2020, before the COVID lockdowns.
“For loan growth to pick up and narrow this gap in any material way, banks would have to sustain an abnormally high average growth in loans for at least two years,” says Ethan Heisler, a longtime bank analyst who is now a senior adviser at Kroll Bond Rating Agency. He adds that a recession would exacerbate that challenge.
Thus the focus on reducing deposits, which ramped up an average of 35 percent during the pandemic as customers sought FDIC-insured safety. “Some banks have even joked about giving toasters away to customers for withdrawing deposits rather than bringing money in,” says Frank Farone, managing director at Darling Consulting Group.
Humor aside, Farone said, banks are deploying strategies aimed at walking the sensitive line between reducing deposits to more sustainable levels while retaining reliable customers. To do so requires an emphasis on deposit customers, using both data analytics and an institution’s own expertise (which may be new for many bankers).
The asset side of the balance sheet has been mixed. The rapid increase in interest rates this year has bolstered returns on banks’ investment portfolios, but lethargic lending has resulted in historically low loan-to-asset ratios and prompted lenders to compete on loan rates to capture assets, squeezing the capital ratio.
“The market remains awash in liquidity and some institutions are compressing spreads below historically tight levels to gain volume,” says the treasurer of a publicly traded commercial bank in New England.
That leaves banks with little choice but to lower, or at least stabilize, their liability costs, and the leap in interest rates has actually made that task easier by giving some customers incentive to move their deposits to more lucrative investments. In June, the average deposit rate for checking accounts was 0.03 percent and 0.08 percent for savings accounts, according to the FDIC, while investing July 15 in one-month, risk-free Treasury bonds provided a par yield of 1.98 percent, with still higher rates anticipated.
However, too much of a lag in raising deposit rates could risk losing customers whose deposits are likely to provide stable funding in the longer term. The New England treasurer says that “many of the medium-sized and large players are waiting on market competition to see who blinks first with large deposit-rate moves.”
Such calls may fall to chief deposit officers, who at typically sit at a bank’s asset-liability committee table. “It’s a relatively new position that we’ve not seen a lot of historically,” says Steve Kinner, senior managing director at IntraFi Network, a provider of deposit solutions and overnight funding options. “Some banks are very creatively approaching this issue by creating a high-level position that just focuses on deposits.”
Hammond, Louisiana-based First Guaranty Bank hired Mark Ducoing as CDO in April 2019, for example, and Planters First Bank, based in Cordel, Georgia, tapped Dan Duchnowski in February 2020 to hold the position.
Bill Handel, chief economist and general manager of Raddon, a Fiserv company, says the CDO trend actually began before the pandemic, in response to factors transforming deposits from a “raw material” generated as inexpensively as possible to a highly sought-after funding resource. Those factors include the unprecedented wealth transfer between baby boomers and millennials, the adoption of digital tools and the emergence of fintech firms competing for those funds.
“This is another case of a trend that the pandemic rapidly accelerated,” Handel says.
Banks are also encouraging their officers to proactively communicate with deposit customers, especially the largest ones, Kinner explains, similarly to longtime communications with large borrowers.
That proactive communication has helped New Canaan, Connecticut-headquartered Bankwell increase loans by 20 percent in 2021 and into the first quarter of 2022. Matthew McNeill, EVP and chief banking officer of the $2.5 billion asset bank, says officers communicating regularly with deposit customers has been a part of the business-focused bank’s strategy since its start 20 years ago.
When the pandemic struck March 2020, the bank’s staff called all borrowers, and its regular contact with them enabled quick assessments of their credit status and reduced its initially large portion of deferred loans. It has also proactively phoned or met in person with large depositors to assess their satisfaction and whether additional steps should be taken to maintain the relationship.
“It’s always been our practice, but it’s been especially useful in a rising rate environment,” McNeill said. “We have a very robust treasury management team that helps us continue growing our non-interest-bearing deposits, and we offer working-capital lines of credit that often lead to more deposits.”
The bulk of banks’ deposits come from a small minority of consumer and business customers, so it is critical to identify them. That customer segment will drive banks’ net interest margins, the New England treasurer says, and they must “walk the line” between taking care of customers and locking in a high cost of funds as a recession looms.
“Deposit pricing and deposit betas are the number one topic among management, with growth being a close second,” the bank treasurer says. “When and how much to raise deposits are the two biggest questions.”
It’s also important to understand when customers are less rate sensitive. Sam Sidhu, president and CEO of Customers Bank, says the West Reading, Pennsylvania-based bank’s single point of contact business model enables the lending teams to cross-sell deposits, especially sticky, low-cost deposits in service accounts such as cash management and instant payment.
“Those services incentivize our clients to stay with us over the longer term,” Sidhu says. The bank reported total cost of deposits declining by 20 basis points to 0.33 percent in the first quarter of 2022 compared to a year ago.
Only a portion of large deposits, especially those that have grown rapidly over the pandemic, may be rate sensitive. Bankers must determine where that line is and whether and how to retain those deposits.
Handel at Raddon says that further segmenting large accounts by looking at their fund flows and the destinations of outgoing funds is another key step, to build relationship-pricing models that proactively push out higher paying deposit products when rate sensitivity increases. He pointed to JPMorgan Chase as a large bank that has been very effective at combining high-tech data analysis with high-touch customer contact, opening branches in new markets and maintaining more bricks and mortar than most.
Among variables banks may consider when making deposit product and pricing decisions, Farone says, include the impact of account size on rate sensitivity, the yield curve and liquidity needs. Also, whether increasing deposit rates or rolling out promotional products will cannibalize existing relationships and increase the marginal cost, and the extent to which former CD balances are now sitting in non-maturity deposit accounts, since they will likely be among the first movers as rates rise.
Darling research shows non-maturity deposit accounts represent fully 87 percent of deposits with the rest CDs as of April, compared to a near-50/50 split in 2007, when the divergence began to increase and then accelerate at the start of the pandemic.
“Essential to maintaining margins is how well banks manage their cost of funds,” Handel says, adding that it will be especially important as banks resolve the current deposit excesses but also so banks can identify longer-term deposits and stay relevant in the baby boomer wealth transfer in the decades ahead.
“In the short term, rates are rising, and if I have excess deposits and let some walk I help myself,” Handel says. “I also have to understand demography and consumer and business trends as well as my competition and avoid making a short-term decision that hurts the bank in the long term.”
John Hintze is a frequent contributor to the ABA Banking Journal.