Bankers are grasping to find a new conventional wisdom on deposits.
The quest for core deposits was supposed to be king in the new back-to-basics, retail-driven business model. But some advisers are now recommending the opposite: Slow down deposit-gathering, given that banks are making fewer loans.
Many banks, still winnowing their loan portfolios after the financial crisis, are having to invest their excess deposits in securities or bonds until lending rebounds. The problem is, some of these instruments are not yielding that much — sometimes even less than the banks are paying on deposits — or could come back to bite the bottom line if interest rates begin to rise too quickly.
So it just might be worth it to curtail deposit promotions.
"Right now, every bank is making a decision about how much funding they really need," said Aaron Fine, a partner in the retail and business banking practice at Oliver Wyman Group, a New York management consulting unit of Marsh & McLennan Cos. "If you don't have loans to fund, then you're going to have to park your deposits into securities, which are paying less than you are paying for your deposits."
Granted, deposits grew in recent years without much effort from banks as investors fled the stock market. But banks this year have redoubled their deposit-gathering efforts to bolster consumer banking and improve liquidity.
A fair number of banks with loan-to-core-deposit ratios well above 100% have offered special promotions on money market accounts to gather sufficient deposits to reduce that ratio to 90%, said Andrew Frisbie, a vice president at First Manhattan Consulting Group.
Banks that need to reduce their ratios should think carefully about how aggressive to be in acquiring deposits, Frisbie said. Their front-line employees typically offer the higher-yielding products to practically everyone, he said, so that, in meeting the company's ratio goal, they raise the cost of most of the deposit portfolio.
Striking the right balance is difficult. Even Frisbie cautioned that bankers risk upsetting customers who could provide long-standing relationships.
"Banks want to continue acquiring core transactional relationships that bring along with it money markets and" certificates of deposit "because, in the long run, that's where the majority of the retail bank's earnings power comes from," Frisbie said.
Jeff Davis, an analyst at First Horizon National Corp.'s FTN Equity Capital Markets Corp., said that banks flush with deposits but lacking loan demand may be tempted to invest in generic bonds that carry very low coupons. But such banks could face massive losses if interest rates rise too rapidly.
That said, Davis predicted that most banks would still rather boost core deposits and face interest rate risk.
"So many banks had a scare from a liquidity standpoint last fall that they are going to welcome deposits with open arms," he said, "as long as they have the capacity to pay off wholesale borrowings and replace them with cheaper deposits."
Banks are steadily reducing their loan-to-core-deposit ratios, Davis said. During the boom years before the crisis, many banks had ratios above 100%. But now they are aiming for 80% to 90% loan-to-deposit ratios, he said.
Tom Broughton, the president and chief executive of the $1.6 billion-asset ServisFirst Bank in Birmingham, Ala., said that his institution is currently generating a negative spread on its deposits because loan demand is "tepid." However, the bank's board has decided it is worth the pain to attract more core deposits, most of which are in money market accounts.
"We're trying to take a long-term view, and so we want to build market share, even though we have a negative spread," Broughton said. "At one point, loan demand will get better, and we'll have those deposits to fund loans."
There may be ways to minimize the risks.
Robert Patten, an analyst at Regions Financial Corp.'s Morgan Keegan & Co., said that banks can reduce interest rate risk by investing their deposits in very short-term securities.
FTN's Davis said banks can offset lower returns in securities by letting higher-rate certificates of deposit and borrowings run off the balance sheet.