Rising deposits and falling loans have regional bankers cheering, though market watchers say it's too soon to celebrate.

Loan-to-deposit ratios — a key gauge of how much banks have to rely on outside sources funding — have been plummeting at regional banks across the country as consumers save more and banks lend less.

Though executives at KeyCorp, Marshall & Ilsley Corp. and First Horizon National Corp. have emphasized how falling ratios last quarter helped boost margins and liquidity, some analysts were skeptical. They pointed out that the trend means that lending is weak and deposits are being invested in less profitable alternatives. The situation could harm the economy in the longer run, they said.

Either way, more money has been coming in than going out at regional banks. This has left them awash in liquidity, which has let them juice margins by slashing rates on checking and savings accounts.

It has helped them become — or get closer to becoming — "core-funded," banker-speak for being able to finance new loans from cheap, stable deposits rather than with pricier money from the government or other lenders. Regional banks' lifeblood is the rate spread between loans and deposits. The spread generally widens when banks have more deposits to lend.

"We're well-positioned to fund an eventual upturn in loan demand," Bryan Jordan, the president and chief executive of First Horizon in Memphis, said in a conference call with analysts.

KeyCorp and M&I said their falling loan-to-deposit ratios should let them permanently alter their funding profiles.

A year ago, Milwaukee-based M&I's loan-to-deposit ratio was 124%. Now it is essentially at par. M&I aims to keep its ratio "a lot closer to 100 as we go forward than we were in the past," CEO Mark Furlong said in an analyst call.

Cleveland's KeyCorp plans to keep loans matched with or less than deposits from now on after its ratio fell to 86%, from 106%, a year ago.

"We have established that we will be a core-funded institution," Jeffrey Weeden, Key's chief financial officer, said on April 21. He added that, with "loan demand remaining soft" and "liquidity remaining strong," Key's net interest margin has benefited from paying lower rates on deposits.

Though bankers raved about the benefits of the falling ratio in the first quarter, market watchers saw nuances. They said it is debatable whether the trend is good for the economy or country.

On one hand, moving away from borrowing money to fund loans is clearly positive because the credit crisis was hastened when wholesale funds dried up, putting some institutions on the edge of insolvency. Deposit-funded loans are also among the most profitable products in banking.

"It definitely cheapens their cost of funds," said Maclovio Pina, an analyst at Morningstar Inc. "They now have cheaper money to loan out to other customers."

But therein lies a major rub: Banks are not lending much right now, and the prospects for near-term consumer and commercial loan growth are dim with employment and the housing market still on shaky ground. Whether banks are simply being stingier with credit or people are borrowing less: Lending is down.

"Loans are falling at 6 or 7% for most of the regional banks that we follow. Deposits are growing about that fast," said Anthony Davis, an analyst at Stifel Nicolaus & Co. who covers institutions in the Midwest. "It speaks to the fact that the last four months have been the four weakest reporting months since 1947 for outstanding bank loans, according to the Federal Reserve."

David Dietze, the chief investment officer at Point View Financial Services Inc., said the falling ratio could have ominous implications for the economy because oversaving and underlending can lead to deflation.

"It basically indicates a contraction of the money supply," he said. "It's a contractionary force when you have the lack of credit creation that a lower loan-to-deposit ratio implies."

Davis said another seeming benefit of a falling loan-to-deposit ratio — an abundance of liquidity — is not necessarily healthy for banks in the long run. Every dollar that a bank does not lend is a dollar that is not making it as much as it could. Banks have been ramping up investments in securities, which do not generate as much profit as loans. Securities are also more vulnerable than loans to interest rate risk, a major concern in recent months. Lenders have been parking their excess cash at the Federal Reserve, which also does not earn them as much as loans.

Excess liquidity is weighing on margins even as they are bolstered by lower deposit costs. "The extent that margins are holding or even widening in the face of that is testament to how far deposit costs are falling," Davis said.

But the trend cannot last forever; banks have been letting costly deposits run off their books for more than a year now.

Also, there is no guarantee that banks will be able to hold on to their robust deposit balances as the recession eases, said William Schwartz, the senior vice president of U.S. financial institutions at the DBRS ratings agency.

He said fickle consumer savings habits and competing investment products could reverse the industry's deposit growth of the last two years.

Bank executives also should be cautious about highlighting falling loan-to-deposit ratios, Schwartz said, because they did not really do anything to foster the trend. Banks are not really managing funds better, he said. People are borrowing less and saving more.

"They shouldn't break their arms patting themselves on the back too hard," he said. "Most of this didn't come from great strength or great marketing. It came from the dynamics of the environment."

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