Banks See Margins Widen by Deposits Surging to Most

Profit margins at U.S. banks may get a boost from increasing deposits as customers show a preference for immediate access to their money and less appetite for risk with interest rates at a record low and the economy still seeking a bounce from recession.

Commercial banks in the U.S. added $88.9 billion of so- called core deposits in the third quarter, bringing the total to $6 trillion, the most since at least 1992, according to the Federal Deposit Insurance Corp. Wells Fargo & Co., the fourth- largest lender by deposits, and fifth-ranked U.S. Bancorp have said they’re competing for such funds, which include checking and savings accounts and time deposits of less than $100,000.

Banks are relying more on deposits for funding after a freeze in credit markets sparked the financial crisis and led to the bankruptcy of Lehman Brothers Holdings Inc. in September 2008. The industry must shift from raising funds in debt and securitization markets to increasing core deposits, which pay little or no interest, analysts say. The average rate of 0.80 percent on bank deposits is the lowest since at least 2000, according to Market Rates Insight in San Anselmo, California.

“Other sources of funding are drying up,” said Christopher Whalen, a former Federal Reserve analyst and co- founder of Institutional Risk Analytics in Torrance, California. “The banks that have stable funding will inherit the earth.”

Shrinking Leverage

Banks consider core deposits more dependable in times of stress since customers with checking and savings accounts are more likely to keep their money in the bank than bond investors or lenders. Lehman and business lender CIT Group Inc., financial companies more reliant on credit markets, filed for bankruptcy when their traditional sources of funding vanished.

Borrowing by U.S. commercial banks fell 17 percent since July of last year, while deposits, excluding large time deposits, increased 9 percent in the same period, according to the Fed. About two-thirds of the core deposits added by banks in the third quarter, or $59.4 billion, were deposits that don’t pay interest, according to the FDIC.

Leverage, the ratio of assets to total equity, fell in the second quarter to 8.8, the lowest since 1988, for banks with more than $20 billion in assets, according to federal data. Total deposits rose to 56.3 percent of assets at 22 of the 24 firms in the KBW Bank Index through Nov. 22, from 50.3 percent at the end of September 2008, according to Siddharth Jain, a bank analyst at KBW Inc. Citigroup Inc. and McLean, Virginia- based Capital One Financial Corp. don’t provide figures.

Banks relied on deposits to fund 81 percent of the growth in assets during the third quarter, the FDIC said Nov. 23.

‘Shift in Funding’

“One of the most overlooked aspects of the current cycle is the secular shift in funding,” said Todd Hagerman, a banking analyst in New York with Collins Stewart Plc, a London-based brokerage. “We’re seeing ongoing deleveraging, which means less reliance on wholesale funding and more reliance on core funding sources.”

Core deposits are also valued because banks can lend the money at higher rates or profit just by purchasing securities. Buying two-year Treasuries would net lenders the spread between the cost of the funds and the notes’ yield, currently about 0.5 percentage point.

Customers who provide core deposits, particularly those with checking accounts, are thought to be the most loyal and least likely to defect to competitors because they have an active and involved relationship with the bank, according to Richard Hartnack, a vice chairman and head of consumer and small business at Minneapolis-based U.S. Bancorp.

‘Safe Storage’

“We’re acting as a safe storage place for people’s liquidity, and we’re also acting as the institution that is effecting payments for them,” Hartnack said. “As long as we do a good job, most clients are happy with the value proposition.”

Checking-account holders are more likely to sign up for other products such as debit or credit cards, overdraft protection, or a savings account, Hartnack said. Research shows they stay with the bank longer than any other customers, except those with 30-year mortgages, he said.

Through the first three quarters of this year, JPMorgan Chase & Co. had the biggest percentage increase of domestic deposits that don’t pay interest among the six largest U.S. commercial banks, according to company filings. The New York- based bank, the second-largest by deposits, reported a 7.5 percent increase to $219.3 billion.

Wells, U.S. Bancorp

Wells Fargo, based in San Francisco, boosted noninterest- paying deposits by 1.7 percent, while U.S. Bancorp reported a 6.7 percent jump and Pittsburgh-based PNC Financial Services Group Inc., the sixth largest by deposits, was up 3.8 percent.

Bank of America Corp., based in Charlotte, North Carolina, and New York-based Citigroup, which rank first and third, reported fewer deposits that don’t pay interest. Bank of America lost 1.5 percent of such deposits over the period, while Citigroup’s fell 9.7 percent.

Robert Julavits, a spokesman for Citigroup, said the bank’s overall noninterest-bearing deposits, if foreign accounts are included, increased through the first nine months of this year.

Jerry Dubrowski, a spokesman for Bank of America, said the bank’s retail deposits increased this year. The decline in noninterest-paying deposits was the result of the sale of First Republic Bank, and a “conscious decision” to reduce the number of checking-account customers, while others moved into savings accounts that pay interest, Dubrowski said.

The increase at JPMorgan was driven by deposit growth in commercial banking and treasury services, said Tom Kelly, a spokesman for the bank. Fred Solomon, a spokesman for PNC, declined to comment.

Core Deposits

“Core deposits remain important to us as the best source of funding for new loans to our customers and as the foundation for deep and lasting relationships that we can build on,” Howard Atkins, Wells Fargo’s chief financial officer, wrote in an e-mail.

The U.S. savings rate has averaged 5.7 percent of disposable income this year, up from 3.1 percent in the prior decade, according to the Commerce Department. U.S. companies are holding $943 billion in cash, Moody’s Investors Service said Oct. 26. Consumers saved $1 trillion in domestic bank accounts in the three years ended October, according to Market Rates Insight.

“We’re in this new era of deposit behavior,” said Nancy Bush, an independent bank analyst based in Annandale, New Jersey. “Deposit levels in the banking system will be higher than in the past because consumers will be spending less and saving more, even when the economy picks up.”

‘Stickier’ Deposits

The increasing pool of core deposits, and a greater reliance on them, has led to more competition among some banks.

“I have instructed our team to be aggressive on deposit gathering,” Richard Davis, chief executive officer of U.S. Bancorp, said on the company’s earnings call Oct. 20. Whichever bank “goes into the recovery with the most customers -- with the most deposits, especially core deposits -- will end up winning the next cycle. So, we’re not backing down.”

Wells Fargo’s Atkins said on a conference call Oct. 20 that increased deposits will help the bank’s net interest margin, the spread between interest paid on deposits and received on loans, since it shrinks the amount the bank must pay out to other sources that cost more. The bank reported an 11.2 percent rise in checking accounts in New Jersey during the third quarter from the year-earlier period, and a 9 percent increase in Florida.

“Those are more relationship-oriented and are stickier and a more stable source of funding than just CDs or money-market accounts,” said Blake Howells, an analyst at Becker Capital Management Inc. in Portland, Oregon, who spent 13 years at U.S. Bancorp.

‘Rotten’ Yields

For the most part, banks have used core deposits to buy securities as loan growth stays flat or declines. Between June 30 and Nov. 10, commercial banks bought about $121 billion of Treasuries and agency-related debt, compared with $47 billion in the first half, according to the Fed. Commercial and industrial loans outstanding have fallen by about $65 billion this year, central bank data show.

It may be difficult for banks to keep the deposits they’ve attracted once interest rates rise, according to Bert Ely, a banking consultant in Alexandria, Virginia.

“These yields are so rotten, you park the cash in the bank not because you want to, but because there aren’t many good options,” Ely said. “When things start to pick up, you will pull that cash out.”

Average Rate

The average rate on deposits calculated by Market Rates Insight, which provides data and analysis to financial services companies, is based on a sample of 1,300 U.S. commercial banks and credit unions and includes checking, savings and money- market accounts, as well as certificates of deposit, according to Executive Vice President Dan Geller.

Fed policy makers cut the overnight lending rate between banks to a record low range of between zero and 0.25 percentage points in December 2008.

When rates do rise, the cheapest deposits will become even more valuable, leading banks to fight for any market share they’ve taken, said Timothy Coffey, an analyst at FIG Partners LLC in San Francisco.

“You’re going to want to find a way to minimize that increase” in funding costs as rates on savings accounts rise faster than asset yields, and adding low-cost deposits is the best way to do that, Coffey said.

‘Huge Win’

Deposits will also become more valuable as other types of funding remain scarce, said Whalen of Institutional Risk Analytics. The FDIC on Nov. 9 said it would change the rules for the deposit-insurance fund to penalize lenders that rely more heavily on borrowings from the Federal Home Loan Bank system.

FDIC-insured institutions cut FHLB advances by $43 billion in the third quarter, marking the eighth consecutive quarterly decline, the FDIC said Nov. 23.

In the past, banks have funded residential and commercial real estate loans by bundling them into bonds and selling them. Less than $40 billion of commercial mortgage-backed securities have been issued this year, down from more than $250 billion in 2007, according to data compiled by Bloomberg. Without healthy securitization markets, banks will keep loans on the balance sheet, where they will have to be funded with debt or deposits, Whalen said.

“Any bank that can access core funding and build a business on top of that is by definition going to be more stable,” Whalen said. If banks can fund assets with deposits, he said, “that’s a huge win.”

To contact the reporter on this story: Dakin Campbell in San Francisco at dcampbell27@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

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