Deposits or Not, Banks Need to Fund Loans

Deposits or Not, Banks Need to Fund Loans

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What do government stimulus, risk aversion, and job insecurity all have in common? They all played significant parts in deposit growth at our nation’s banks during the pandemic. Between year-end 2019 and March 31, 2022, bank deposits grew 37% (from $14.5 trillion to $19.9 trillion).

Non interest bearing deposits, which currently represent a little more than a quarter of the total, grew more than 73% during that time (9 months or 2¼ years). Interest bearing deposits grew by 26.5%. Now that influx of deposits is starting to ebb back out of the banks.

At September 30, 2022, non interest bearing deposits were down 6.2% from their peak and interest bearing deposits were down 1.6%. But, while total deposits dropped by 2.9% during the second and third quarters of 2022, they are still considerably higher than they were pre-pandemic.

Non interest bearing accounts are preferred by many bankers: they do not incur any interest expense, nor do they incur the same scrutiny as things like “brokered” deposits or “Hot” money. These non interest bearing, or core deposits, are basically a free loan for the bank. Bankers love them, so do regulators.

Savings accounts (CDs included), on the other hand, do incur an interest expense. And while CDs, in particular, are committed for a specific length of time, these deposits are often placed by those chasing higher yields (like JRN subscribers). As non-core deposits, there is no real expectation, by either party, of a long-term relationship.

In spite of reporting growth in total deposits during the 12 months ended September 30, 2022, the 51 banks listed on page 5 each also witnessed a reduction of 24% or more in non interest bearing deposits. (Also, non interest bearing deposits were greater than $5 million at 9/30/2021.) In these cases, the banks retained the deposits, but it will cost them.

There are benefits to knowing (or believing) that deposits will stay, even if there is a price to pay for them. Deposits are used to fund loans. But, what happens when total deposits shrink and loans grow the same time? That was the case for hundreds of community banks during the period ending 9/30/22.

Remember Accounting 101? assets = liabilities + owner’s equity

That still applies. Banks need the deposit liabilities to fund the loans (assets). If there is higher loan demand than can be met with deposits, banks turn to Fed Funds, Subordinated debt, borrowing (i.e. Federal Home Loan Bank Advances), to fill the gap and maintain capital ratios. Banks owned by a holding company also have the option of down-streaming funds from there.

5-Star Bessemer Trust Company, N.A., New York, NY is an interesting example. Year over year, Bessemer Trust reported growth in coveted non interest bearing deposits, but a huge drop in its interest bearing deposits bringing total deposits down by 39% (to $1.6 billion). At the same time, Bessemer’s loans increased by 42%. In order to keep owner’s equity intact, Bessemer drew from other assets (cash and due from other banks, of which it had an abundance) to fund the loans.

In so doing, total assets decreased (over 32%) to counterbalance the decrease in deposits. Bessemer is one of many banks that used this approach. In Bessemer’s case, it reduced its investment portfolio in conjunction. Perhaps it did not want to draw its cash levels too low.

5-Star Middlesex Savings Bank, Natick, MA drew down its cash as well, but it also employed another tactic. It borrowed, to the tune of $275 million. It borrowed from Peter to lend to Paul, at a higher interest rate, we presume. This is another totally reasonable and common way to fill the deposit gap.

In the case of Middlesex SB, total assets grew by 2% over the year. Owner’s equity, however, was down by 15%. That was a calculated decision by a bank that could afford to let that happen. Even with that hit to equity, its leverage capital ratio is 11.97% and its total risk-based  is 16.65%. Middlesex SB has been around since 1835; it knows what it’s doing.

Several banks decided to purchase Fed Funds to help fund loans. In fact, many banks used a combination of several of these method, like 5-Star Platinum Bank, Oakdale, MN. In Platinum’s case, deposits decreased by $46 million and loans grew by $65 million (a $111 million change). Just shy of 100%, Platinum’s loan to deposit ratio is extremely high.

What did it do? It reduced its cash by $112 million, purchased $3.7 million in Fed Funds and borrowed almost $15 million. As a result, assets dropped 3.9%, and owner’s equity grew by 6.6%.

Platinum Bank has a leverage CR of 9.85% and a total risk-based CR of 13.4%. It boosted its loan loss reserves (just in case) and it still managed to post a profit: $2.101 million for the third quarter 2022 and $6.207 million year-to-date. Established in 2007, Platinum Bank does not have the same length of experience as Middlesex, but we like how it operates. All three of these banks we’ve used as examples also have holding companies above them they can lean on.

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