Maturing CDs Offer Relief to Banks in Rate Squeeze

A heavy load of pricey deposits might be a good thing in this interest rate environment.

Funding costs fell hard and fast at the nation's bank giants as the Federal Reserve slashed short-term rates to next to nothing in late 2008, while smaller competitors trailed behind because they rely more heavily on certificates of deposit that take time to mature.

Recently, the decline at smaller banks has outpaced as large institutions appear to have approached a floor through which they can drop no further.

But even among big banks, major differences in sensitivity to market rates are apparent in relative holdings of time deposits.

Among a group of 26 bank holding companies with more than $40 billion of assets, the average cost of funds at the eight institutions with the highest proportion of time deposits to assets at June 30 fell 78 basis points from the third quarter of 2009, to 1.37% in the second quarter, nearly catching up with the average at the eight with the lowest proportion, according to data from Financial Information Systems (see charts).

Both groups have taken advantage of loose monetary conditions to rotate out of time deposits, but banks that have traditionally relied heavily on term funding have had more room to maneuver as low rates have set in for the foreseeable future.

In fact, the average net interest margin at the CD-laden group increased by 75 basis points since the third quarter of 2009, to 4.21% in the second quarter, while the average net interest margin at the group with small amounts of time deposits fell.

Now, banks with big CD portfolios could be in line for another dollop of disproportionate funding relief despite an otherwise painful twist in the rate environment.

Analysts at Keefe Bruyette & Woods say they expect companies like Regions Financial Corp. and KeyCorp to be buffered by declines in CD rates. However, they say, Wells Fargo & Co. could be pinched particularly hard because of its already-low cost of funds and the high yield on its securities portfolio.