Why the small-bank deposit gap could widen

Small banks have been steadily losing deposits for years, and the trend could worsen if they keep letting credit unions and larger banks outbid them for depositors’ funds.

Financial institutions generally have started paying higher rates on deposits now that the Federal Reserve has raised the fed funds rate five times since late 2015. It could approve as many as four hikes this year.

Since the December rate hike, the average 1-year certificate of deposit rate at banks and credit unions tracked by RateWatch rose from 0.346% on Dec. 18 to 0.379% on Feb. 19.

But financial institutions aren’t all moving at the same speed. Online banks like Ally Bank and Goldman Sachs’ Marcus platform have increased rates the fastest, according to Joshua Siegel, CEO of StoneCastle Financial, a provider of deposit services to community banks. Credit unions have also raised rates quickly, and analysts expect big banks and regionals to follow suit later this year — if not sooner.

Many community banks haven’t raised deposit rates much, if at all, Siegel said. That’s a risky strategy, he said.

“It’s a dangerous game,” Siegel said. “It’s not a switch on the wall you just turn on. If you telegraph that you aren’t going to be changing your rates, customers are going to shop around.”

More than ever, retail customers are rate-sensitive and can easily switch to another bank that pays better for savings accounts, money markets or CDs, said Neil Stanley, CEO of The CorePoint, a community bank consulting firm.

“Everyone who walks into a bank has a smartphone and the moment they start talking to a banker about interest rates, they pull out their phone and Google CD rates,” Stanley said. “They will say, ‘Here’s what I can get,’ and that’s a stark reality for a banker.”

The smallest banks are already struggling when it comes to liquidity, in contrast to midsize and large banks and credit unions. From the end of 2013 to the end of last year, total deposits rose by double-digit percentage rates at banks with $1 billion in assets and larger, and at credit unions. However, at banks with less than $1 billion in assets, total deposits fell 7.5%.

Liquidity losses could accelerate if community banks fail to keep pace with larger banks and credit unions that have raised deposit rates, Siegel said. That could threaten the lifeblood of any depository institution.

“Why would you want to risk damaging that?” he said.

As of March 1, the highest rate on 5-year CDs were offered by three online banks, according to NerdWallet; Barclays, Capital One 360 and EverBank each offered 2.65%.

The $91 billion-asset Navy Federal Credit Union on Thursday announced it will extend the offer period for a 15-month CD with a rate of 2.25%.

In late February, the $4.7 billion-asset University of Iowa Community Credit Union raised deposit-product rates “to ensure our pricing is among the best in the markets we serve” as well as to make them competitive with online banks, CEO Jeff Disterhoft said.

“It’s a competitive world,” Disterhoft said. “We have to be cognizant of online banks’ CD rates.”

Big banks are likely to raise rates at a faster clip the next time the Fed raises the federal funds rate, Marty Mosby, an analyst at Vining Sparks, wrote in a Feb. 23 research note. The largest banks have steadily boosted loan rates after the Fed’s recent rate increases, which helped them improve returns on equity. Now that they have established that base, large banks will start raising deposit rates, he said.

Executives at large and regional banks have started to indicate they are ready to boost deposit rates. The $23 billion-asset Prosperity Bancshares in Houston plans to raise its CD and money market accounts by 80 basis points for every 100-basis-point increase in the prime rate, CEO David Zalman said on Tuesday at the Royal Bank of Canada Financial Institutions Conference.

Other regional banks expect to see their rivals take the same steps as Prosperity soon.

“I think banks will fight a little bit harder for deposits,” Mark Tatterson, chief financial officer at the $19 billion-asset United Bankshares in Charleston, W.Va., said Wednesday at the Raymond James Institutional Investors Conference. “That will pick up in 2018.”

To be sure, many community banks don’t have a pressing need to boost deposit rates. Banks in rural areas, where there are few other competitors, are typically safe to keep deposit rates low, Siegel said.

Banks with low loan-to-deposit ratios also tend to lag deposit rate increases. The $1.7 billion-asset Central Valley Community Bancorp in Fresno, Calif., has only raised rates on select products because it has plenty of core deposits to meet loan demand, CEO Jim Ford said.

“Our liquidity levels are great,” Ford said. Central Valley’s loan-to-deposit ratio was 62% in the fourth quarter. “We try to pay attention to what our competitors are doing and what online banks are charging, but it’s not going to cause us to change things.”

But many other community banks are getting left behind. It’s easy to understand why many community banks are reluctant to raise deposit rates, since it can result in lower net interest income. But it is a tough decision that many bankers need to address, and soon, Stanley said.

“You’re between a rock and a hard place. You want the funds, but you don’t want to pay market rate,” Stanley said. “But unless you start to pick up the pace, the cumulative effect of the Fed’s multiple rate hikes will put you behind the market.”