Banks at a loss what to do with glut of deposits

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Banks have had no problem gathering deposits during the coronavirus pandemic. The challenge is what to do with them until the economy recovers and loan demand returns.

Deposits at banks jumped by 13.3% in the first quarter from a year earlier, to $15.8 trillion, the biggest year-over-year increase measured by the Federal Deposit Insurance Corp. The industry’s loan-to-deposit ratio fell from 71.9% to 68%.

Fed data has since highlighted several weeks of double-digit deposit growth in the second quarter, including the week that ended June 3.

Several factors are at work. Consumers and companies were hoarding cash during the earliest days of the outbreak. And many small businesses have been holding onto funds from the Paycheck Protection Program, which launched in April, while determining how to navigate the forgiveness process.

Low-cost funding is invaluable for banks, especially when they have an opportunity to use the money to add higher-yielding assets. But the interest rate on PPP loans was capped at 1% and other lending opportunities are few and far between.

Those factors, along with near-zero interest rates, could eventually pinch margins and further pressure profits, industry experts warn.

“Deposit growth continues to outpace loan growth by a very wide margin, which will surely be a factor in NIM compression as banks appear to be awash in liquidity,” said Scott Siefers, an analyst at Piper Sandler.

The banking industry’s net interest margin compressed by 29 basis points in the first quarter from a year earlier, to 3.13%, according to the FDIC. The yield on earning assets shrank by 54 basis points, to 3.87%.

At the $77 million-asset American Metro Bank, which focuses on Chicago’s Chinatown community, Chairman and CEO Patrick McShane said that, since the onset of the pandemic, deposits have increased by about 8% on an annualized basis. The growth was notable given that the bank had not set out to add deposits in the first half of the year.

McShane attributed the growth in large part to the PPP as new and existing customers deposited funds prior to deploying them. McShane said he hopes to eventually use the funds to help Chinatown’s restaurants and shops find their footing as Chicago gradually reopens.

“A whole lot of uncertainty” remains, McShane said. “There’s been a lot of pain, and while we’ll do everything that we can to help restore businesses, it’s not clear how many will survive this.”

If another wave of coronavirus forces a second shutdown, “it’s hard to imagine the fallout … and the damage it could do across commercial real estate,” he added.

Absent lending opportunities, banks may have to look at ways to thin out interest-bearing deposits in the second half of the year. That could be difficult; deposits were steadily rising at banks prior to the pandemic.

There is a positive element to the numbers. Growth in non-interest-bearing deposits, which rose by 14% during the first quarter, outpaced that of interest-bearing accounts, whose balances increased by 6.4%.

That should help banks maintain their margins in the short term, industry observers said.

“Still, there will inevitably be some downward pressure, and there are costs that go with managing all these accounts,” said Kevin Jacques, a former bank regulator who is the finance chair at Baldwin Wallace University in Ohio.

“Banks will look at letting any higher-cost deposits they have run off, even if it means losing some small relationships,” Jacques added. “I don’t think that, with all the uncertainty on credit quality, they’re going to go out and take a bunch of risk just to show loan growth. Not until people really know this pandemic is solved.”

Margin pressure has to intensify at some point, said Shan Hanes, president and CEO of Heartland Tri-State Bank in Elkhart, Kan. While inflowing deposits are cheap, three-fourths of the $123 million-asset bank’s loans have variable rates that are falling as a result of the Fed’s rate cuts.

Credit quality and economic conditions are also concerning.

“Business owners are just scared by all the uncertainty — really scared about what the next six months will look like,” Hanes said.

Deposit growth has been “extremely strong” at CNB Bank & Trust in Carlinville, Ill., after skittish customers retreated from the stock market, said Shawn Davis, CNB's president and chief executive. PPP funding amplified the trend, leading to nearly $100 million in new deposits this year at the $1.3 billion-asset bank.

Like all bankers, Davis is actively managing margin risk. But what concerns him more is the fear of more outbreaks that could deliver another shock to economic growth.

“If this gets protracted," he said, "this could get really ugly.”

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Deposits Net interest margin Coronavirus Paycheck Protection Program