In Search of Low Cost Funding

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We know very well that it’s not what you want to hear, but community banks are in need of low-cost (or no-cost) deposits. Two weeks ago (JRN 36:38) we reported on some creative ways community banks are raising total deposits, which are desperately needed to fund loan growth.

This week we go a step farther. Some of the community banks on page 7 were among those listed with the most overall deposit growth, but the majority are deliberately focusing on raising noninterest bearing deposits. It’s not easy, but it is necessary. Although, looking at highlights from the FDIC’s second quarter Quarterly Banking Profile  (QBP) may not give that impression.

For example, the second line of the QBP says, “Net Interest Margin Remains Stable at 3.39 Percent”. The second paragraph continues with, “Net Interest Income Expands 3.7 Percent From a Year Earlier”. Someone just skimming the headlines might think we’re sitting pretty. We’re not, and here’s why.

“Since year-end 2018, the average yield on earning assets rose by 1 basis point, while the average cost of funding increased by 11 basis points.” In other words, for every percent increase in loan earnings, the cost of deposits needed to fund those loans rose 11%. That is simply not sustainable.

So while the industry net interest margin of 3.39% may not sound bad, it is significantly lower than its most recent high of 3.48% in the fourth quarter 2018 and, if current trends continue, the squeeze will be on before we know it.

To make matters more complicated, noninterest income for the industry dropped 2.7% from a year ago. The main driver of the decrease was servicing fee income, which was down $3.1 billion. At the same time, noninterest expenses rose 1.4% or $1.6 billion during the 12 month period, with over 75% of the industry reporting an increase.

The silver lining here is that these expenses were attributed to salaries and employee benefits, which were up by $1.8 billion (3.2%). Loans also increased during the year so the average assets per employee increased from $8.4 million at June 30, 2018 to $8.8 million this June.

The challenge then is to attract low cost (or no cost) deposits to fund an increased loan demand that they hope will continue. And that takes some thinking outside of the box, or inside the box, as the case may be.

5-Star Mid-Central Federal SB, Wadena, MN, the first bank on page 7, increased its noninterest bearing deposits from $171,000 at June 30, 2018 to $7.311 million at June 30, 2019. To accomplish this, Mid-Central offers incentives to “faithful” business customers. In return for maintaining $100,000 or more on account (including loans, CDs, savings, checking, and IRAs) at the bank, the first 300 items that pass through their business account each month are free. It needs the deposit growth and, to its credit, it is not paying brokers to bring it in.

At June 30, 2019, Mid-Central’s loan to deposit ratio was 105.4%, much higher than the 80.1% average of its peers. Almost two-thirds of its loans are tied up in single family homes, which are generally long-term. Another 18% is extended for consumer loans. That leaves just 18% for all other loan categories compared to 65% at its peers.

Aside from robust growth in noninterest bearing deposits, the second bank listed on page 7, 5-Star Malvern NB, AR, is almost the exact opposite. Its loan to deposit ratio is lower than the norm at 66.8%, with only 15% of total loans made to fund single family residential loans and consumer loans.

Malvern’s technique is to attract deposits from younger generations. This is evidenced by its Free Value Checking, which includes free online and mobile banking, free e-statements, free mobile wallet and mobile deposits. Malvern has also partnered with Zelle® to enable its customers to send money directly to anyone within minutes. Building relationships virtually is no longer an oxymoron, but an increasingly viable, if not necessary, business model.

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