Fighting for Deposits

Bankers and other major business leaders have no doubt celebrated the return of a powerful U.S. economy over the past couple of years and promising signs of continued economic success. But with all the positive signs, including strong earnings and upbeat investor calls, there’s a bit of still one major issue that most bankers are concerned about.

For several years, banks have often been described as being flush with deposits, an accurate assessment mainly due to consumers being far more cautious in investing and spending money with the vivid memories of the crisis that financially crippled millions of investors and consumers alike, and led many to pile up savings in the event that another blow would put them under completely.

“People got careful about where they had their money,” says Tim Reimink, a managing director at Crowe LLP, a bank advisory and consulting firm. “They lost it in the stock market in the recession and so people were keeping a lot of money in their bank accounts-in their savings accounts-because they didn’t have really a better safe place to put it.”

But in recent years that trend has reversed itself, which has created a good-bad scenario. Tax reform and the likelihood of easing regulatory frameworks are good in the eyes of most bankers, but a vast majority of bank executives say there is a tougher competitive environment for deposits, resulting in higher funding costs and leading to a declining confidence index among bankers, according to a recent survey of about 300 bankers by Promontory Interfinancial Network.

“It’s a little bit of a seesaw, where deposits come into the institution when they don’t need them and it’s really tough to keep them there when they do, and that’s right now,” says Scott Hildenbrand, a principal and chief balance sheet strategist at Sandler O’Neill + Partners.

According to the Promontory study, roughly 90 percent of bank executives across all asset sizes say there will be increased competition for deposits, while 92 percent say funding costs will be higher. The survey captures a paradoxical situation where bankers are optimistic and upbeat about the economy, but are also worried about increasing competition for core deposits.

“Actually it makes a lot of sense,” says Paul Weinstein, a senior adviser and consultant for Promontory, which works with thousands of banks nationwide. “On the one hand you have the economy doing well, but at the same time, the underlying factors of the business are getting tougher.”

The highly competitive drive, which is only becoming increasingly tense, to boost deposits has inspired creative plays from banks of all sizes and locations that they hope carves out an advantage against their like-sized peers, and even the megabanks that are putting intense pressure on the entire industry.

What has been driving this competition? There is more demand for credit while the Federal Reserve has also been raising interest rates, which could put pressure on the funding costs of many banks as they try to keep pace with rising loan volume. The Fed’s rate hikes draw the most attention, but it’s much more complicated than that, according to Hildenbrand, who says equity markets and subordinated debt have also contributed to the cost of, and competition for, deposits.

“When you see offensive capital being raised, and when you couple that with your top 10 competitors in your market having loan-to-deposit ratios that are finally in the 80s, and 90s and in certain pockets cases over 100, that’s driving cost-of-funds changes a little bit more than the [Federal Reserve],” Hildenbrand says.

Of course, the Fed’s boosting of the federal funds rate has played a significant factor in this competition, mainly in flattening the yield curve, which can have a negative impact on bank profitability.

“For every loan, I used to make a 3.5 percent spread, now I have to do a loan and a quarter, loan and a half to offset the margin compression because of the flat curve and more importantly because the spread is tightening,” Hildenbrand says.

That scenario is especially threatening to smaller community banks, which are increasingly feeling pressure from larger institutions that can more easily survive on a much thinner spread, have better technology including feature-packed mobile apps, extensive branch networks and seemingly bottomless marketing budgets. Large banks also gobbled up close to a third of the total deposit base across the country, with banks above $10 billion in assets being the only ones to show deposit growth year-over-year, according to a recent FIG Partners analysis.

Kevin Tylus, president of the banking division of Bryn Mawr Trust Co. in Bryn Mawr, Pennsylvania, with just shy of $4.5 billion in assets, calls it one of the biggest threats to small community banks, especially those under $1 billion in assets, about 3,500 banks nationwide. But rural banks, he says, have an advantage because most attention by the largest institutions and even the top 20 banks is paid to booming urban areas where deposits and popular commercial and industrial (C&I) loans opportunities typically thrive.

Rising interest rates have drawn widespread attention from all sectors of the public, consumers, analysts and news media alike. The federal funds rate, of course, is one of the primary litmus tests that signal the general health of the economy in the eyes of many consumers and the Fed. The rate has been bumped up seven times (175 basis points) since 2015, at the time of publication. It’s closely watched by banks because of its direct influence on their ability to maintain healthy profit margins on their lending operations.

The Fed’s last rate hike was in June, and it is expected to raise rates at least one and possibly two more times in 2018, which is beginning to make many bankers increasingly uneasy as they feel pressure from the rising rates while their own rates for their depositors and borrowers trend relatively flat, which could threaten their ability to generate earnings growth.

Essentially, it’s almost become a game of chicken for banks, especially among the smaller institutions that can only withstand so much.

“I think the ability to grow deposits is the greatest challenge and biggest risk that community banks face in terms of their financial success, and quite honestly, their ability to remain independent,” Tylus says. “It’s becoming more of a challenge to fund loan growth with traditional core deposits.”

How each bank reacts to the new rate environment will be influenced by a variety of factors, from geography and local growth patterns to a complex competitive environment-including whether the bank should do an acquisition or sell out to a competitor.

“Banks probably today are at some of the highest loan-to-deposit ratios that they have ever been, and so the competition for liquidity is very intense,” says Frank Sorrentino, CEO of ConnectOne Bancorp, a $5.1 billion asset bank based in New Jersey.

In fact, the balance in that particular ratio is as skewed as it has been in decades; some banks are approaching or already at 100 percent, a position that is risky and unlikely to be palatable for long with regulators or risk officers. As banks manage their paths through this challenging and competitive landscape, what’s become clear is that no one prescribed strategy stands out as the preferred method to increase deposits to fund their own asset growth.

Some banks have added new product lines like wealth management services, which can increase the ability to grow deposits especially from current customers. Others have begun to raise their deposit rates, a near inevitability that is being led by digital banks that have greater pricing flexibility.

“Banks will need to diversify their deposit products and their business lines,” Tylus says. “Bryn Mawr Trust has done both with enhanced sweep accounts, a new money market fund and a growing wealth management business now near $14 billion. These give the customer more deposit options.”

Other banks have brought in new talent that is focused specifically on deposit growth, and others are adding deposit growth as a measure in performance evaluations.

First Choice Bancorp, headquartered in Cerritos, California, recently switched to a new core technology provider, which included a new treasury management system. First Choice CEO Robert Franko says the new system expands the bank’s capabilities for its most valued corporate clients, and opens the door to more potential deposit growth. The new system has all of the glitzy functions of the top-tier banks, which is a major concern for smaller banks like $908 million asset First Choice. “It keeps Wells Fargo from stealing your best clients, because they will,” Franko says.

What’s clear is that for the first time in nearly a decade, bankers are in a challenging position of managing a transition to a higher rate environment that essentially requires banks play offense and defense at the same time.

Emprise Bank, a state-chartered bank with $1.7 billion in assets headquartered in Wichita, Kansas, has been growing deposits in recent years between 3 and 5 percent, and while that’s good news, even its balance sheet was skewed when CEO Matt Michaelis took over at the turn of the year after serving as the bank’s board chair. His background includes a career advising M&A transactions for investment firms Salomon Brothers and Greenhill & Co. and starting his own private equity firm.

“We were kind of in the wrong direction, we were far too light on loans, and we built that side of the business and now we have to keep growing both,” he says, while describing a “sweet spot” that Emprise and dozens of other banks are trying to find.

“As I look at it, there’s an optimal balance sheet mix for us as you look at investment securities and loans on the asset side as relative to deposits on the liability side and we are now in a good spot from that mix perspective,” he says.

To help strike that balance, Michaelis says the bank has focused on increasing its team of lenders, and hired a commercial banker to focus on growing deposits. It’s so important that some of the compensation packages are weighted toward deposit growth. “Deposits or deposit growth are now in every conversation that we have,” he says.

And so it is in virtually every bank boardroom in the country. “Wherever you go this is receiving attention,” said Dave Koch, president and CEO of the consulting firm Farin & Associates, during a recent webinar hosted by Bank Director and Promontory. “It’s getting harder and harder to buy money at the price that we want.”

Perhaps the most straightforward approach is to simply buy a bank that is flush with deposits. Bar Harbor Bankshares, in northeastern Maine, acquired Lake Sunapee Bank Group in Newport, New Hampshire in May 2016, which has helped boost its deposit base. Bar Harbor had the second-largest deposit growth year-over-year among publicly traded banks, according to data from S&P Global Market Intelligence. The Lake Sunapee acquisition boosted its deposits by 125 percent, and that helped fuel its asset growth, which went from $2.3 billion in assets to $3.5 billion. The growth wasn’t a fluke, and in fact, Bar Harbor CEO Curtis Simard had it planned from the day he took over in 2013 after a career at TD Bank.

“We bought a bank that had a lot of deposits that didn’t know what to do with them,” Simard says. The negotiations to acquire Lake Sunapee Bank Group began in late 2015 and the all-stock, $143 million deal closed in January 2017, ultimately expanding the bank’s network to 50 branches in three states, a move that largely preempted the current climate that is only increasing in competitiveness.

“I brought a lot of commercial lending buddies with me, and we weren’t buying it because of the assets, you can be sure of that,” he adds.

Simard says the move was intentional and capitalized on an opportunity he knew was coming before “we felt that others would catch on and M&A would start becoming deposit-based and not asset based,” he said. And sure enough, some banks are paying a premium to acquire franchises that are strong in core deposits especially, Simard says, a view echoed by others across the industry.

And in February of this year, First Choice acquired Los Angeles-based Pacific Commerce Bancorp, a $536 million asset bank that brought with it $425 million in loans and $464 million in deposits-a deal that was aimed specifically at growing its core deposit base. The purchase was part of a broader strategy, but while “screening for what sorts of transactions makes sense, high on that list was, does that bank have a strong core deposit franchise,” Franko says.

Though First Choice went after a deal to boost its deposits, the purchase is part of a multi-faceted strategy the bank has to continue its growth in Southern California, which is not focused on consumer deposits, though the bank does take some in its immediate footprint. In Franko’s mind, what’s the point?

“No matter how aggressive you are about consumer deposits, you’re always competing with Wells (Fargo) or Bank of America or (JPMorgan) Chase or all three of them with a branch on every corner,” Franko says.

First Choice, which is heavy in commercial and industrial real estate, wants to leverage its strong position in those markets to gather more deposits. If the bank finances an apartment complex development, for instance, it wants the tenants to have an account with the bank as well.

“We want their personal deposits, we want their company deposits, we want their friends’ deposits and we want references-warm introductions-to other clients that they know,” Simard says.

The bank has also added talent focused specifically on deposits, putting an emphasis on culture within the bank that rewards that skill set, and not just talent with experience in banking.

“We look outside of banking and bring those people in and say, ‘Hey you want a challenge? Let’s sell a commoditized product in the form of cash. It’s the same color as every other bank, show me how good you are,’ and we pay them on performance,” says Simard.

To some, the buildup for the wholesale reshaping of how bankers look at their balance sheets seems like the run-up to major military conflicts. Headlines in financial outlets use terms like “arms race” and “war for deposits,” but those who are on the front lines are not just waging war on others. Those attacks have not become common, though there is no shortage of awareness of the intense competition among institutions, regardless of size or geography, thanks to the lessened importance of traditional geographic boundaries and the ability to collect deposits digitally.

At the same time that banks are trying to devise an offensive strategy, they also need to protect the core deposits they already have.

In this context, that defense strategy would be essentially keeping the depositors in place, and preventing account holders from leaving for one reason or another, whether it be a hot-money situation or the convenience of being able to do anything and everything on the go. Added to this are restructuring moves of human capital, as well as lines of business that increase the ability to capture deposits, but also an additional opening for competition from other providers.

For Bryn Mawr, which is in an especially competitive market in Philadelphia, Tylus says there was no other way to maintain and grow its core deposit base but to expand its offerings and price its own rates competitively. Its commercial and consumer lending is still funded by its core deposit base, but “the rest of the company produces about 40 percent of our revenue,” he says. Its wealth management division and private banking group have $13 billion in assets under management, he says.

While there seem to be plenty of strategic options to remain competitive, the current market is only going to grow more intense, having a bigger impact on smaller community banks first, but will eventually ripple up asset level hierarchy.

“There’s just more competition than ever,” Tylus says.