Will the long-term effects of excess deposits accelerate bank consolidation?


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More than a year after deposit growth started to soar, financial institutions remain inundated with deposits and demand for loans has remained stubbornly weak, putting pressure on net interest margins. But this is only part of the difficulties that banks and credit unions face.

Businesses and commercial borrowers, who are expected to lead a recovering economy, themselves face a severely disrupted supply chain, which means that even if they wanted to borrow to grow their businesses, they are stuck in a shortage. material history. As a result, many beneficiaries of paycheck protection program loans worth trillions of dollars over the past year have placed those funds in deposit accounts instead of reinvesting them in the economy.

Key question:

Will lower net interest margins discourage investors in financial institutions and subsequently accelerate industry mergers?

On the other hand, while recognizing what some are calling an unprecedented economic challenge, financial institutions have found ways to deal with excess liquidity issues throughout the pandemic period. These include stepping up efforts to attract new customers, enter new markets, increase marketing to generate new loans, reduce the importance of deposit products, and even remove deposits from balance sheets. In addition, banks and credit unions have embarked on new lines of business.

“I don’t think many of us thought that a year after the pandemic [started] that our balance sheets would be considerably bigger ”, observes Jill Castilla, CEO of Citizens Bank, Edmond, Okla. Although, as she points out, excess liquidity is a better problem to have than the other way around.

“It used to be about deposits, deposits, deposits and loan growth based on loan growth,” says Robert Kunisch, president and chief operating officer of Baltimore-based Howard Bank, which has been in the industry for over 30 years. “And now we find ourselves inundated [with cash]. “

Although the situation is not as bad as the lack of liquidity, bankers appreciate the serious impact of the situation. “[Clients] We just don’t need the money today and I think until they are able to start building up stocks here, we’re going to have a hard time, ”said William Demchak, CEO of PNC Financial Services, at the Bernstein Strategic Decisions Conference.

( Read more: What Financial Institutions Need to Know About Inflation Now)

How PPP Loans Helped Squeeze Margins

The numbers reveal the harsh reality: In just 14 months, the total amount of deposits in commercial banks rose from $ 14 trillion to $ 17 trillion in June 2021, according to the FRED economics database of the Reserve Federal of Saint-Louis. Ellen Zentner, managing director and chief U.S. economist at Morgan Stanley, estimates that between March 2020 and April 2021, U.S. households accumulated about $ 2.2 trillion in total excess savings.

Very liquid bank balance sheets

March 31, 2021
(in billions of dollars)
QOQ change YOY change
Total loans $ 10,825 -0.40% -1.20%
Total loans (excluding PPP) $ 10,356 -1.00% -5.50%
Total titles $ 5,479 7.20% 30.20%
Total federal funds and pensions $ 298 11.50% 4.40%
Interest-bearing balances $ 3,357 14.80% 54.20%
Cash and non-interest bearing balances $ 271 2.80% 18.00%
Total deposits $ 18,459 3.60% 17.00%

Source: S&P Global Market Intelligence

Meanwhile, loan balances declined 1.2% year over year (or 5.5% excluding loans made under the Paycheck Protection Program). Median net interest margins fell to 3.31% in Q1 2021 from 3.37% in Q4 2020, while the median among the 20 largest US banks fell to 2.10% from 2.18 % last quarter, according to S&P Global Market Intelligence. The industry’s loan-to-deposit ratio fell to 58.64% in the first quarter of 2021, from 69.48% a year earlier.

A big source of deposit influx has been the disbursement of PPP funds to support small businesses during the pandemic.

The best plans:

The theory was that beneficiaries would reinject PPP funds into their businesses and communities. Instead, many have parked the funds in deposit accounts.

“We isolated all of these PPP loans into new checking accounts to do our best to try to track how our clients were using these funds,” Kunisch explains. “The challenge was that some customers moved them instantly to their main operating account. “


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What could accelerate consolidation

In the background lurks the specter of a profit squeeze, which could have serious consequences.

“A bank is not going to go bankrupt because it doesn’t have the same amount of loans it did before,” said Josh Siegel, founder and CEO of StoneCastle Partners. The financial brand. “But a bank will see its profitability diminish. If this happens, which investors will come?

“If the rate of return is not attractive enough, shareholders will eventually decide to withdraw, which will dry up capital and push banks into bankruptcy.

– Joshua Siegel, StoneCastle partners

“We are not going to see billions of dollars in additional savings from households and businesses absorbed into loan demand overnight,” said Greg McBride, chief financial analyst at Bankrate.com. “This is why you are going to continue to see consolidations in the banking sector. “

The key is how long financial institutions have to wait for an increase in loan demand. “The margins have certainly been squeezed, but the economy is picking up speed,” says McBride. “So the potential that we see in increased demand for loans holds promise for financial institutions that are sitting on excess deposits. “

( Read more: How Consumers Prioritized Debt Payments During the Pandemic)

In the short term, he says, part of the strategy for removing deposits from bankruptcy is to start pricing them non-competitively and increase the marketing of loan products. It’s an avenue that Howard Bank took.

Before the pandemic, the Maryland institution was actually seeking new funding for its mortgage company by offering promotional rates on CDs, “Now we let these just get away or stay on the books, but renewed at a significantly lower rate, ”explains Kunisch.

But it doesn’t go any further, says Siegel.

“We have a lot of banks that have said [to customers] not only do I not want any new money, but I will close your account, ”says Siegel. “We have others who just said I won’t pay anything, and the money is still coming in, because where else are you going?” “

Commercial loans will be the key

Another approach to getting rid of deposits is to arrange with companies like StoneCastle and IntraFi to place the deposits of high balance depositors with a network of other banks. This is what Planters First Bank in Perry, Georgia does. “The advantage for the bank is that we maintain the relationship, but that we can withdraw the funds from the balance sheet if necessary”, explains Dan Duchnowski, director of marketing.

But even StoneCastle’s Siegel says that’s not the whole answer. “There is no return,” he says. In addition, according to Duchnowski and Castilla, who have also used these options, sometimes they have become fully subscribed and can no longer take deposits.

All these bankers see the demand for commercial and industrial loans as the key to the rebound of the economy as well as their liquidity situation. But many companies face shortages of raw materials or products due to major disruptions in supply chains, resulting in a shortage of everything from microchips to plywood.

“The biggest component of loan demand will be stockpiling, which is not happening yet,” PNC’s Demchak said. “You look at the sales to inventory ratios, they’re as low as they’ve ever been. “

“A good example is the lumber industry,” says Castilla. “Right now, costs are exceptionally high, pushing up house prices and lowering the supply of new homes. McBride says this situation is expected to improve over the next 12 to 24 months, eventually leading companies to continue funding new capital investments.

( Read more: How a community bank is reinventing itself for future relevance)

Make all possible adjustments

Faced with this headwind, Howard Bank decided to aggressively expand its market with a new sales team that brought with it a number of long-term relationships. The result was record loan origination in the fourth quarter of 2020 and the first quarter of 2021. In addition, the bank’s correspondent mortgage group, launched in September, managed to fill the refi runoff from its portfolio by focusing on jumbo mortgages, according to Kunisch. The $ 2.6 billion asset bank has also invested in maritime brokerage operations, which are prevalent in the Chesapeake Bay area, “Just in time when everybody in America buys a boat,” said the CEO.

The much smaller Citizens Bank looked at its core competencies. “We are a very traditional community bank,” says Castilla. “We have a lot of small business clients dominated by consumer deposit accounts and then some larger business account types. On the lending side, we are primarily commercial real estate loans and small business loans.

His bank, which has assets of $ 352 million, provides consumer loans, but that area has been weak. The low supply of new and used cars translates into stable loan opportunities.

Even so, Castilla sums up the prospects for hope among the bankers interviewed here: “I think there is a lot of optimism in the economy about our ability to recover. There is so much pent-up demand that the main concern is the supply chain and when we can stabilize it. “

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