Deposit Trends Are Deteriorating As Powell Makes First Move

March 21, 2018 | Andrew Frisbie, Chrystal Pozin and Adam Stockton

Today, as the FOMC raises rates by another 0.25% and signals more hikes in the future, Novantas proprietary data makes it clear that the sands have shifted. Commercial lines of business are suffering from balance declines and remixing into higher-cost products. Consumer brick-and-mortar money market deposit account balances are shrinking for the first time in years. Direct bank CD prices have risen to the critical 2.00% level, exhibiting a beta of more than 100% since December.

Many of these recent trends are likely to accelerate if rates continue to climb. As a result, banks face tactical pricing decisions with much higher stakes than at any point over the last ten years. At the same time, they will have to grapple with strategic decisions about how to allocate scarce investment resources.

CONSUMERS WANT YIELD, BANKS START TO DELIVER

Until recently, this cycle’s slow and steady dose of Fed Funds increases resulted in relatively muted consumer-deposit responses. In the past six months, however, two developments signal a sea-change in customer behavior. After nearly a decade of uninterrupted growth, consumer MMDA balances have begun a persistent decline. Direct-banking CD betas, meanwhile, have topped 100% since December as these institutions seek to mitigate even more costly pricing of their large legacy portfolios. Taken together, these developments herald a phase similar to the second set of four Fed moves in 2004-2006, when betas gave back the lag that had been won during the first four hikes.

According to our proprietary Comparative Deposit Analytics (CDA), industry consumer MMDA balance growth stalled in the second half of 2017 — and actually declined for a majority of banks in our CDA group. The decline was driven by existing customers who pulled balances from these accounts after years of building them.

Consumer CDs grew at 2% in 2017 for the same CDA peer set, breaking from a similarly-long declining trend. Some banks have been impacted more than others. Institutions that are pricing CDs at a significant premium to the market have seen short-term CD growth of 33% in 2017, relative to a 10% decline in those who have shied away from aggressive CD offers.

Consistent with pre-crisis higher rates, yield premiums for off-balance sheet money market mutual funds (MMMFs) relative to money market deposit accounts (MMDAs) deposit rates have now risen enough to shift deposits off balance sheet. Additional FOMC moves will increase this differential, as well as motivate consumers to shift out of deposits (Exhibit 1).

Like MMMFs, the differential between direct bank liquid pricing and brick-and-mortar continues to increase from 0.03% in 2015 to 0.50% or more. In Novantas’ historical benchmark analysis, this level of rate gap has led to a major shift in both acquisition and cannibalization; we expect to see further shifts from Savings into CDs (Exhibit 2).

DIRECT BANKS CONTINUE TO HERALD BROADER CONSUMER TRENDS

As covered in our March 2017 FOMC perspective, direct banks continue to be a herald of broader consumer pricing trends. Within direct bank MMDA, aggregate promotional betas have been a cumulative 60% ahead of today’s announcement (with liquid rates moving from 1.05% to 1.75%).

Cumulative betas for CDs are even higher at 80%, and in fact are over 100% since December’s move, given their 0.35% average increase. This jump is explained in part by handle rates; banks skipped pricing shorter-term CDs at 1.75% and jumped to 2.00% in the hope of attracting disproportionate new volume. At the same time, they spared their large liquid portfolios from additional price increases.

As pricing on brick-and-mortar short-term CDs climbs closer to 2.00%, the optics of handle rates present another opportunity for customers to exhibit more price sensitivity. If these trends continue, CDs will become more of a growth vehicle in all classes of banks as pressure continues to mount on savings and MMDA deposits.

COMMERCIAL DEPOSITS SHRINK, REMIX TO HIGHER COSTS

Recent commercial-deposit performance reveals another tipping point: 2017 ended with disappointment, frustrating bankers who had been lulled by steady commercial deposit growth.

The Novantas Commercial Deposit Study found that two-thirds of commercial units saw balance declines in 2017. While most units experienced a welcome bump of seasonal growth in the fourth quarter, it was insufficient to prevent annual balance declines on a year-over-year basis. Novantas sees three trends that are contributing to the erosion of low-cost balances.

First, within on-balance-sheet deposits, commercial bankers have largely held the line on standard rates for earnings credit rate (ECR) demand deposit accounts (DDAs) and MMDAs under 0.25%. Exceptions in both deposit classes are rising, however, with maximum ECR DDA exceptions now frequently at 0.75% and MMDA exceptions at 1.15% or higher. Our conversations with bankers reveal increasing pressure to move standard rates soon as they are torn between maintaining widening spreads and mitigating attrition. When standard rate clients leave for competitors due to low rates, banks face significantly higher cost to replenish balances from competitors through new-deal pricing.

Second, higher rates are driving decreases in ECR DDA balances on two fronts — increasing the incentive for commercial clients to move ECR balances into higher-yielding alternatives, as well as reducing required ECR holdings to offset treasury management fees. As covered in our December 2017 FOMC Perspective section “A new dawn for IB DDA”, the rise of this product is changing portfolio composition relative to previous cycles (Exhibit 3).

Third, competitive offers are frequently disconnected from potential customer elasticity. Within commercial MMDA, for example, the competitive exception rates that banks offer for new deals range from 0.20% to 1.75%. Client work has shown that many portfolios have significant tranches that were unnecessarily priced higher, while other deals were lost due to a lack of competitive rates.

Intra-deposit pricing tells only half the tale. Net balance declines from commercial customers owe much to the growing beta divergence between on-balance-sheet offerings and other liquidity instruments. Betas for MMMFs, Commercial Paper, and Treasury Bills range from 70% to 90%, eclipsing what deposit-takers are willing to offer on a broad basis (Exhibit 4).Maintaining deposit volumes at desired costs requires deep analytical and scenario-based understanding of client behaviors, and a willingness to make difficult trade-offs.

CONCLUSIONS

Although well-constructed deposit models predicted many of these recent changes, most banks still solve for a single top-down deposit growth goal. Such plans ignore foreseeable changes in deposit gathering and cost changes in the rate environment, resulting in suboptimal outcomes. Identifying growth plans under a multitude of scenarios will ensure that the enterprise can adequately set expectations and align quickly on strategies in a rapidly changing environment.

In an era of scarce investment resource, banks must be able to measure the returns on deposit-gathering investments across lines of business rather than in functional siloes. CFOs should be deeply involved in these trade-offs that, by definition, an individual line of business cannot make — whether that means adding commercial relationship managers, increasing consumer marketing expenditures, or setting a thin-network expansion.

That doesn’t mean that individual lines of business are off the hook. Commercial and retail units need better analytics and benchmark data to measure the flow of funds, exception handling, and customer offers. Forward-looking plans avoid knee-jerk price reactions that almost always are value-destroying. Institutions need the runway to build out additional product or capability improvements so they can compete effectively as the environment turns ever more competitive.