Deposit glut could dog banks well into next year

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The flood of deposits that poured into banks during the first half of 2020 was expected to be temporary.

But general unease about an economy that’s been clobbered by the coronavirus pandemic — and fear that there is more pain to come — continue to drive down consumer spending and commercial loan demand, leaving banks awash in record-level deposits with few ways to put the cash to work. While interest rates at near zero are making that cash relatively cheap, net interest margins have narrowed and profitability is a concern.

Liquidity could stay high if lawmakers negotiate a second round of aid for consumers and businesses — perhaps over $1 trillion on top of the $2.2 trillion already injected in the spring — and recipients of Paycheck Protection Program loans keep their money in the bank because of uncertainty about the economy or loan forgiveness terms.

“I think people are not expecting much in the way of diminished dollars until 2021,” Randy Rosen, vice president of deposit products at FBX, said of deposit levels.

To find near-term relief, some banks are paying near-zero rates on deposits and eliminating higher rates for new or preferred customers. Some are using the inflow to buy mortgage-backed securities or make other investments. Other banks are parking cash at the Federal Reserve, where it earns at least some interest.

Regions Financial in Birmingham, Ala., is doing all three, plus employing a hedging strategy put into place about three years ago to protect net interest margin in anticipation of a low-interest-rate environment, according to David Turner, chief financial officer of the $144.1 billion-asset company. At June 30, Regions held $116.8 billion of deposits, its highest ever, he said.

“We would love to take [the excess cash] and make loans,” Turner said. “But there just aren’t a lot of opportunities to grow right now … and I don’t think we’re going to see a lot of loan growth in a period with this much uncertainty about the economic recovery and the pandemic.”

Deposit balances have been skyrocketing for most of the year, rising $1.2 trillion in each of the first two quarters of the year, according to the Federal Deposit Insurance Corp. The uptick stemmed from a rush of credit-line drawdowns in March and, starting in April, a series of federal stimulus efforts including PPP loans to small businesses and government payments of $1,200 to many individuals.

Between Jan. 1 and Sept. 23, the latest date for which information is available, deposits at U.S. commercial banks rose 19%, according to the Federal Reserve Bank of St. Louis. As of that date, deposits at those banks totaled $15.7 trillion.

All of that deposit growth is putting pressure on banks’ net interest margins. At midyear, the average net interest margin for the industry declined to 2.81%, the lowest level ever reported in the FDIC’s quarterly banking profile, as asset yields fell at a much faster rate than funding costs.

During industry and investor conferences last month, executives from banks such as JPMorgan Chase, Wells Fargo, U.S. Bancorp and Comerica said deposits continued to be elevated and could remain so for the rest of the year.

Third-quarter deposit numbers "will be certainly strong relative to the third quarter of last year, relatively flat to up a little bit [compared] to the second quarter,” U.S. Bancorp Chief Financial Officer Terry Dolan told investors during a Barclays conference in September. “But we do expect deposit growth to continue through the end of the year, and that's really tied to a lot of the Fed actions that are taking place.”

To manage the extra cash, one bank is charging customers to hold deposits. According to a recent Bloomberg article, starting next year UBS Group will charge international wealth management clients who live abroad and hold deposits in Switzerland a fee of $360 a month for holding 500,000 francs or less.

Analyst Brian Klock of Keefe, Bruyette & Woods, who tracks large U.S. regionals, said he hasn’t heard of any of them actively discouraging deposits. Without knowing how the economy will shake out and facing prolonged low interest rates, banks may be feeling “stuck” in terms of what to do with the cash, Klock said.

But there is a sense that whatever excess money banks are holding is ultimately temporary, he said.

“I think what banks are realizing is that if things get worse with the economy, those deposits won’t be around,” Klock said. “And if things get better, those deposits won’t be around.”

At Comerica in Dallas, average deposits are expected to total $68.6 billion for the third quarter, according to a filing. That’s up 23.2% from the third quarter of 2019 and 6.7% from the second quarter.

During an industry conference last week, retail bank executive Cassandra McKinney said customers of the $84.4 billion-asset bank are being “very cautious” about spending, especially small businesses that received PPP funds. Without knowing how the PPP loan forgiveness process will work or when a COVID-19 vaccine will be ready, it’s hard to say when depositors will start spending the money.

“I think what we all know is the coffers are absolutely full from a deposit perspective and the [loan-to-deposit] values are absolutely low and that’s not necessarily a winning combination,” McKinney said.

Deposits at Chemung Canal Trust Co. in Elmira, N.Y., are up about $300 million since the start of the year, mostly on the commercial side, President and CEO Anders Tomson said. Like many of its peers, the $2.1 billion-asset company found that deposits rolling into the bank haven’t been spent down as expected.

Loan demand excluding PPP loans has been “modest,” so some of the money that the bank can’t lend is being shifted into overnight deposits and mortgage-backed investment securities, Tomson said.

So far, the elevated cash isn’t much of a problem because the bank has low funding costs and still makes money, Tomson said. But if deposits are still high a year from now, the picture will be murkier, he said.

“I haven’t thought that far forward,” Tomson said. “I anticipate the country is going to rebound. This is a cycle and we need to be patient.”

None of Neil Stanley’s clients are pushing depositors away. The former bank CEO who now runs The CorePoint, a consulting firm that helps banks collect deposits at low prices, said many are taking the long view on building relationships even as they drive down the price on deposits to manage the balance sheet.

The point is to hang on to customers, he said.

“What’s happening now is that bankers are legitimately listening and watching and trying to pick up all the ideas they can of how to run the bank and help people emotionally and operationally navigate this environment and keep it all together so they are growing the business,” Stanley said.

At Regions, corporate deposits — largely, non-interest-bearing deposits — have grown substantially in the past several months, Turner said. So the bank is taking those deposits and putting them at the Fed. How much? Between $9 billion and $11 billion, far beyond the normal $2 billion to $3 billion, he said.

If the government approves another stimulus package, that means even more liquidity in the system and, at least at Regions, the increased likelihood of buying even more mortgage-backed securities.

“We’ll have to invest more of what’s at the Fed into the securities book,” Turner said. “We’d much rather make loans. Having the economy pick up and having loan production pick up is what we would like to see, because if we take the cash and put it on the loan book, now we have a different ballgame.”

But bankers might have to keep waiting to see a general increase in loan demand. The coronavirus, which has killed more than 208,000 in the U.S., remains strong. And the unemployment rate, which has fallen after skyrocketing in April, was still high at 7.9% at the end of September.

All of which means deposits, at least for the time being, are likely to sit still, FBX's Rosen said.

“Until the economy gets back and unemployment improves, which is predicated on getting a vaccine and a return to normalcy, I think there’s going to be a lot of hesitancy for people to start spending money,” he said.

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Liquidity Deposits Net interest margin Commercial lending Consumer banking Coronavirus Paycheck Protection Program Regions Bank U.S. Bancorp Community banking