Deposit Pricing Creates Divide Among Bankers

Deposits continue to slowly trickle out of the banking system, creating divided opinions over how much bankers should fret over the outflows.

By and large, banks are still awash in liquidity despite the steady exodus of deposits. At the same time, the Federal Reserve Board seems disinclined to halt a strategy that has largely encouraged people to keep money in the banking system.

Still, some bankers are starting to express concerns about liquidity. While it is unlikely that the banking industry will suffer a liquidity crisis like it did five years ago, there are worries that many institutions are ignoring a chance to proactively shore up low-cost funding for future growth.

"I think the industry has been lulled into a sense of complacency about interest rates," Gerald Lipkin, chairman and chief executive of Valley National (VLY) in Wayne, N.J., said during a conference last week in Boston hosted by RBC Capital Markets. Deposits are "a major future problem that is going to hit the industry."

About a third of Valley National's $11 billion in deposits are demand deposits. "That is abnormally high, and a lot of that is just lazy money," Lipkin said.

Lipkin is one of the few bankers warning about liquidity. It is understandable that most bankers view deposits as a low priority. The industry's loan-to-deposit ratio was manageable at June 30, at 70.3%, despite a 0.4% decrease in deposits from March 31, according to the Federal Deposit Insurance Corp.

There are reasons why bankers should pay attention, industry observers say. They are concerned that depositors are starting to factor in expectations of higher rates into their money-management plans and that the cheap money parked in CDs and money market accounts today could get a lot more expensive — or disappear entirely — when interest rates start to take off.

Such a trend would represent a reversal from late last year, when industry observers were worried that banks could weed out deposits. Chris Marinac, an analyst at FIG Partners, warned clients in December that banks could start to reject deposit relationships "unless there are real revenues attached to them."

Since Dec. 31, domestic deposits have fallen 0.5%, to $9.4 trillion, according to FDIC data. At banks with $10 billion or less in assets, the outflows were more pronounced, at nearly 1%.

Individual financial institutions are reporting varying trends with the liability side of their balance sheets. For instance, the $54 billion-asset Navy Federal Credit Union, which had $39 billion in deposits at June 30, is coming off the most successful six months of deposit gathering in its 80-year history, says Michael Christian, the Vienna, Va., institution's manager of savings and checking operations.

Navy Federal's deposit mix is changing. Customers have been shying away from long-term deposits, instead opting to park their money into checking accounts or other short-term instruments, Christian says. While funding is hardly an issue at Navy Federal, depositors are starting to anticipate higher rates, he says.

There are still some bankers who remain confident that they can keep deposit rates low. A big reason is competition; there is a belief that big banks will help keep pricing in check by refusing to raise rates.

"We're not going to raise our rates unless we have to," Dale Gibbons, chief financial officer at Western Alliance (WAL) in Phoenix, said during last week's RBC conference. "Big banks have such low loan-to-deposit ratios and high liquidity, so I don't think they're going to raise their rates."

The Fed would have to raise interest rates by 200 basis points before it would have a meaningful influence on deposit pricing, Gibbons added.

Still, some banks are factoring expected shifts in deposit preferences into their strategies. The $16 billion-asset Valley National has introduced a CD that will reprice every six months, rising from 0.5% to 3% over roughly five years, Lipkin said at last week's conference.

"Nobody is paying anything, but once they start to pay it is going to have a big impact on your cost of funds," Lipkin said. "The industry should be very vigilant about the fact that rates will not stay low forever."

The $4 billion-asset Dime Community Bancshares (DCOM) used excess deposits to replace $10 million of Federal Home Loan Bank advances that matured in the second quarter. In the third quarter, Dime will resume its FHLB borrowing, rather than deposits, to satisfy its funding needs "as a long-term interest rate hedge against future higher rates," the Brooklyn, N.Y., company said in a press release. The company did not return a call seeking comment.

At most banks, concerns about rising rates seem to be definitely on the back burner. Barry Sloane, president and chief executive of Century Bancorp (CNBKA) in Medford, Mass., says the industry will be fine as long as banks pay attention to pricing.

The $3.3 billion-asset Century reported an 8% rise in deposits during the first half of this year

"Taking deposits is what we do," Sloane says. "We'll never turn away a deposit, and we should always be able to make a nickel on every one."

Deposit prices might go up, but that doesn't mean that a liquidity crisis is nearing, Todd Price, president and chief executive of the $4.5 billion-asset S&T Bancorp (STBA) in Indiana, Pa., said during the RBC conference.

"I think the banks will be able to keep the money," Price said. "We'll just have to pay for it."