‘Right-sizing’ deposits and the challenge of short-term CD books

KEY TAKEAWAYS:

—Deposits are looking up. The deposit picture late year has improved, according to BAI’s U.S. State of Deposits. The runoff for consumer deposits has slowed, while small business deposits show growth. Remember: Seasonality has an impact – it is bonus time for consumers and tax season for small businesses – so we know there will be a shift at year end.

—Push and pull. Even with the Fed cutting rates, yield competition will continue to shape the deposit landscape. As the Fed moves, some banks say they’re getting internal pressure from treasury departments to cut rates sooner than other deposit-minded leadership inside the bank might desire.

—CD history lessons. Banks have a high percentage of deposit balances in money markets and CDs with maturities of less than a year, and consumers remain yield hungry. Managing that duration poses challenges to banks as rates go lower. It’s a scenario much different than after the financial crisis, when average CD books were much longer.

TRANSCRIPT

This is the BAI Banking Strategies Podcast. I’m Rachel Koning Beals, senior editor with BAI, joined by two of our research experts to discuss what’s driving deposit behavior, especially after the Federal Reserve has twice pulled the lever on interest-rate cuts, their first moves in four years.

Isio Nelson and Tom Hoscheidt, both managing directors at BAI and working closely with our Research Intelligence, join the podcast to continue the discussion launched during a recent webinar on the State of U.S. deposits. And I chime in with a few questions of my own as BAI lays out the deposit landscape in the final months of 2024 and as 2025 begins.

For a look at the data and charts driving this conversation, you can replay the State of U.S. Deposits webinar at bai.org under the Banking Strategies Webinar dropdown. And find more information there to tune in on December 11 for the next update on the State of Deposits. We’ll return to the Banking Strategies podcast after that update and continue the discussion into next year’s rate outlook, cautious deposit optimism, seasonal patterns and more.

Now… Isio, Tom, let’s get deeper on deposits…

[Isio Nelson] Tom, we just finished up the [BAI] U.S. State of Deposits [webinar] and of course we just got lucky and decided to do it the same time as the Fed’s [first interest-rate cut in four years], which was interesting. But let’s start talking a little bit about some of the results we went through. And you know what we’ve done year to date…you know we’ve seen some good news in there, right? [Deposit] growth is less negative this year than we’ve seen in the past…

[Tom Hoscheidt] On the consumer side, one of the big drivers of the negative balance growth that we’ve been experiencing the last year or so had to do with what was going on with checking balances… During the pandemic, average balances were extremely high; highest that we’ve seen. And so what’s been happening is that consumers have been right-sizing, if you will, their average checking balance… It’ll be interesting to see if that downward trend [of driving down balances] continues. But given that spending has eased a little bit and inflation is easing a little bit, we think that the checking balance run could be close to a close. … Banks have been very competitive on interest rates, particularly with CDs, and that has helped to offset some of the runoff that we’ve seen in money market balances, particularly with large banks.

[Isio Nelson]: Just for context…  last year, we saw checking balances down just over 10% and this year they’re down still. But to your point, it’s only down 4.5 and so giving us that kind of sign … [with] the checking runoff, sounds like we’re getting back to normal. Does that mean that we’re going to be back to positive … toward the end of the year?

[Tom Hoscheidt]: Well, what’s happening now is we have been on this downward trend, and that’s starting to flatten out, okay? And again, we’re not expecting big growth through the late summer, fall season, but what always happens on the consumer side is that we tend to see this year-end surge, and so we may still, you know, be slightly negative going into the end of the year, but then [see] that year-end surge we’re predicting that’s going to bring us up into positive territory. So we think we’re going to be flat to maybe even a positive 1% or so by the end of the year.

[Isio Nelson]: That’s great news. So at the end of the year, everybody’s getting their bonuses and their different things that are happening at the year end, which is going into the consumer side, which you’re saying, could tip us over to positive…  Anything else that might prevent us from going into positive territory again?

[Tom Hoscheidt] If spending would pick up, we might still end up a little bit negative, but generally speaking, what we tend to see is flat to actually slightly rising deposit growth at this time of the year. So again, I think, I think we’re in pretty solid shape for this year, and I don’t believe that we’re going to see any big downturn in terms of deposits. I mean, there is always a risk that banks will not react or will overreact, I should say, to the downturn in terms of rates. You know, with Fed dropping 50 basis points [in September and then 25 basis points in November], from what I understand, [banks] are under a lot of pressure by their treasury areas trying to, of course, maximize margins, and they’re trying to get [bank leaders] to lower rates a little faster than what might be prudent, to hang on to deposits. If that does happen, that could bring deposit balance growth down, we could see more balances leaving banks chasing yield and that would that would be detrimental to that flat to a little bit higher growth that I talked about.

[Rachel Koning Beals]: Similarly, because we are probably only at the front end of a Fed [easing] campaign. And given the sort of surprise/didn’t surprise [in September] with the [more aggressive] 50-basis-point move, is it challenging for banks to deal with a guessing public, guessing small businesses about, you know, timing? There’s always lag, too, as the market catchup up with Fed policy. Any thoughts there?

[Tom Hoscheidt]: Well, again, it’s hard to tell. We haven’t been in a declining rate environment quite like this in the past. I mean going all the way back to after the financial crisis, banks had very long-term CD books, and it took a long time, even though rates dropped very quickly, more quickly than they’re going to drop this time. It took almost six years for us to bring the CD portfolio down, for example, because they just had very long-term CDs, [which] took a long time to get off the books in the last falling rate environment.  … This time around, we’re going to see a more protracted decline in terms of the rate. So rates will be moving much slower than they did in the last two downturns. And so we think that CDs are still going to be a factor, and that’s going to have an impact on, you know, just deposit growth, given how important CDs have become for the bank’s book.

[Isio Nelson]: I think the seasonality that we’re coming into is another factor that they’re obviously looking at and understanding… what type of products may have changed, how consumers have changed overall. But it’s a complex Rubik’s Cube I would think for the banks to figure out how to keep the margin, but not lose deposits and still fund the business…

[Tom Hoscheidt] One of the comments that I heard recently at the CBA deposits and payments meeting I just presented at, there was discussion there that really it’s all short term. Now, banks have a very high percentage of their balances in money markets and/or CDs with maturities less than a year. And with a high percentage of dollars in those two categories, it’s going to be very tricky for them to manage on the way down here, as rates go lower. I think particularly because the consumer has had a taste of higher rates, and they’re going to be seeking yield. I think it’s going to be harder to hang on to some of those dollars given that the money market mutual funds will not have come down.

[Isio Nelson]  Any thoughts on how the digital movement continues to change the [deposit] dynamics, or how investments in branches or non-investments in branches might affect it?

[Tom Hoscheidt] We continue to see the branches being a very important element in the mix, on the business side especially, just to kind of pivot over there. We’re seeing the large banks with the bigger branches have the biggest impact on the positive [business] deposit growth that we’re that we’re seeing. I mean, they’ve got the extensive networks. We think they’re picking up more of the new business checking accounts, and that’s helping checking growth, and that’s overall helping to drive the strong deposit growth that we’re seeing on the small business side. In terms of just digital in general, you know, we think it’s an important part of the mix, particularly in generating sort of additional relationships, or deepening the relationships. A lot of the accounts that we see opened on a digital basis tend not to be the first account that the household opened with the bank; it tends to be a secondary account. And so we do see that as a very important element for deepening relationships and helping, you know, contribute to the deposit balance growth.

[Isio Nelson]: I think we saw 2% 2.5% overall [deposit] growth on the small business side, compared to a negative 1.1% last year…  Thoughts on drivers there?

[Tom Hoscheidt]: So really on the business side, and particularly among the large banks, we’re hitting on all cylinders there… strong growth in checking, money market and also CDs… Most of the regional banks are not having that type of growth. They’re still in the negative and struggling to boost their balances.

[Isio Nelson]: We went through those numbers, too, and think we have some hypotheses. We’ve obviously talked to some of the banks, you know. One is we’ve seen overall growth of small businesses still being fairly elevated. But those are micro businesses, those less than $500,000 sold, props, and things like that. Do you think that’s a big reason, or a portion, maybe, of why the larger banks who cater more towards the micro businesses might be doing better?

[Tom Hoscheidt]: Yeah, I think we’ll know better once we see some additional figures in terms of growth of small businesses and how that’s been going the last couple of quarters. But we do think that that’s one of the contributing factors.

[Rachel Koning Beals]: I know you asked some sentiment questions. Consumers feel one way and small businesses might feel another way, because the inflation picture is kind of confusing for people. Small businesses are kind of interesting to ask because they obviously have a sense of wholesale inflation [and] their loan demand sense is kind of different. Anything to point out when it comes to small business sentiment, now that the Fed is moving?

[Isio Nelson]: Small businesses across the board have been a lot more optimistic than the consumer has been. We’ve always thought that it’s because they’re in more control of their own destiny, right? And things have been good for them to pass on pricing to consumers when it’s gone up without necessarily hitting the bottom line. They’ve been able to, a lot of them, had some cushion in their bank accounts from PPP. So overall, the small businesses, I think, were feeling better than the consumer. The other thing we did talk a little bit about this in the webinar was on the consumer sentiment side, going back to there, is they are more optimistic about their future, almost across the board. The interesting thing though, is, as I tell people, just because they’re more optimistic now doesn’t mean they’re optimistic. And what that means is almost every single one of the places that we’ve looked at, consumers are still not even getting the 40% as far as optimism. They’re using the 30% to 40% range. So that means the majority of consumers are still pessimistic in nature. The difference is that we were in that kind of high 20% to low 30% range before. So it’s going up. It’s getting better. And I think we can all see around us that consumer overall is a little bit weary of what’s going on throughout the country due to inflation, geopolitical factors, natural disasters…

[Isio Nelson]: If the consumers are getting a bunch of bonuses and padding the bank accounts towards the end of the year, as we see every year in and year out, how is that over to the small business side?

[Tom Hoscheidt]:There will be a little bit of a pullback here as taxes are paid, but then we’ll have this fourth quarter build up again, and we anticipate there that, you know, balances are going to grow. The thing that happens at the end of the year on the business side, though, is that we tend to see this year-end sort of runoff, if you will, where bonuses and such are being paid. There are some, you know, movement of funds for tax reasons. So we anticipate that even if we do have a little bit more of a buildup, because we have that adjustment at the end of the year, we’re very likely to end up flat to down about 2% by the end of the year in terms of the deposit growth on the on the business side.

[Isio Nelson]: So we’ve got the consumer who is slightly negative right now, but probably into positive based on seasonality… We’ve got small business that is positive right now but will probably end up being a little bit negative. Still, knowing what’s going to happen from a seasonality perspective helps with predicting the future. Now, thoughts on how that plays out into next year with more rate cuts? Edit his stop to about

[Tom Hoscheidt]:  What we’re looking at for next year is the fact that we’re still going to be in a somewhat elevated rate environment okay with rates expected to be, you know, above 3% over the next couple of years. That’s still an environment where a consumer is going to be definitely looking for yield. We’re not going to see that much of this low-rate “parking” environment that we were at, you know, after the financial crisis and such. So generally speaking, we think it’s going to be a challenge for bankers to grow deposits at a rate over 3% just kind of given the rate environment that we’re going to be in over the next couple of years. Add to that, what they also mentioned [at the CBA meeting] was the treasury departments pushing for them to lower their rates more quickly than what they feel they should, given they need to hang on to some of those deposit dollars. That’s you know, an internal pressure that’s going to make it difficult for them to see much in the way of deposit growth as well.

They [CBA members] were appreciative of some of the trend lines that we showed them for the last two downturns and just how much time they took and sort of what was the structure, particularly of the CD book. And again, in this environment, it’s going to be a slower decline than what we’ve seen in the overall rates. However, we do also have this extremely short-term book, so they’re going to have to be pretty nimble in terms of how they price to maintain those deposits and limit the amount of runoff they see, because consumers are seeking higher yield, and now they’ve gotten used to seeing higher yields.

[Isio Nelson]: Well, Tom, listen, we started these [State of U.S. Deposits] about a year and a half ago, as in the industry was responding to SVB [failure]. We thought it was important know what’s going on, understand some of the history and what influences these different trends have. You know what I will say? We used to say deposits are boring, and it’s going to be a while until deposits are boring. And that’s a good thing, I think.

[Tom Hoscheidt]: Yeah Isio, it’s going to be an interesting time. We’ll see what happens with the election, we’ll see what happens with additional rate reductions … and we’ll see how the banks and the consumers respond.

[Rachel Koning Beals]: I want to thank both Tom and Isio for the great insight into behavior behind the deposit numbers. And I’ll remind everyone to check out the next webinar on Dec. 11. We link to that sign up here on the podcast page and elsewhere at BAI.org. And I’ll jump on with these guys after the webinar again next month for a deeper look into deposits. Thanks to all for listening