Community Banks to Face Increasing Problems from Deposits, Study Finds

By Lisa Getter

The deposit problems already plaguing community banks are not going away. And they may be even more serious than anticipated, according to Deposit Dilemma:  10 Interesting and Surprising Trends from 2018, a new Invictus Group white paper.

The paper explores the movement of deposits, looking at the issue by size of bank and type of deposit, and how deposits faired against loans in the years since the financial crisis, with a focus on 2018.  The groundbreaking analysis was based on public data as well as proprietary data and analytics from the Invictus BankGenome™ intelligence system, which includes loan-level and deposit-level data from banks across the country.

The study found that:

  • The mediocre growth in total deposits last year was at its lowest level in 10 years. Perhaps more importantly, growth occurred at just a handful of institutions, and primarily within price-sensitive instruments, such as certificates of deposit (CDs) and money market demand accounts (MMDAs).
  • The deposit threat to community banks from the four money center banks has yet to emerge, but complacency is not an option. Those four banks (JPMorgan, Bank of America, Wells Fargo, and Citibank) experienced lower deposit growth rates than banks of smaller asset-sized tiers in 2018, likely because of the Federal Reserve’s balance sheet normalization process. These banks are well-positioned to become highly competitive in snaring deposits going forward.
  • While transaction accounts, the highest quality form of deposits, grew by $59.5 million in 2018, almost all the growth (98 percent) was captured by Bank of America. Regional banks with assets between $10 billion to $50 billion had a 3.4 percent decline in transaction accounts, while community banks with assets of $1 billion to $10 billion experienced a 4 percent drop.
  • Community and regional banks were increasingly dependent on MMDAs and CDs to compensate for lost transaction accounts and fund growth in 2018. Retail time deposits represented 36 percent of the total growth in deposits for these banks; yet they only represented 9 percent of total deposits at the end of 2017.  This is a big problem, since retail time deposits are becoming increasingly competitive on price in a digital landscape and the large banks are poised to win a disproportionate share of the future growth.
  • Although MMDAs grew by $85 billion for the industry in 2018, $72 billion or 85% of this growth came from two institutions: Charles Schwab and TD Bank (the parent of Ameritrade).  The study concludes that this growth was likely due to money leaving the stock market at the end of 2018 and is not representative of the so-called raw materials that commercial banks would use to fund loan growth.
  • The smaller the bank, the far more likely that deposit growth failed to keep up with loan growth. Community banks with between $1 billion to 10 billion in total assets saw an incremental loan-to-deposit (LTD) ratio of a troubling 115% percent in 2018.  About 54 percent of banks in this asset size tier have an LTD ratio of 90 percent or greater, a sure sign that the community bank deposit dilemma will eventually lead to curtailed growth, margin compression, liquidity stress, or any combination of these challenges for many community banks.

The study cautions that even if the Fed delays further rate hikes and slows down the pace of QE reversal, these problems will only get worse for community banks.

Even savings accounts may come into play. While these accounts were stable in 2018, they are likely then next battleground in the digital arena, with many online banks beginning to offer interest rates that approach those on CDs, the study notes.

“The deposit situation for community banks is getting increasingly serious,” says Adam Mustafa, the study’s author.

“The only practical solution for those banks with high LTD ratios is M&A,” Mustafa says.  “At minimum, the right acquisition of a bank with a healthy amount of excess deposits and favorable loan rate absorption provides an insurance policy against the situation getting far worse.”

He said the Fed’s decision to slow down is good news for community banks because it gives them time to act. “Hoping for falling rates is not a strategy and if rates fall, we are likely in a recession, which presents a different and perhaps even worse situation for community banks,” he says.

The study is available for download or can be read on the web here: Deposit Dilemma – 10 Interesting and Surprising Trends from 2018.