We Need a New Funding Strategy

In December 2021, when the Fed Funds Rate stood at 0-25 basis points and prior to the Fed's tightening beginning in the first quarter of 2022, there were $18.2 trillion in domestic deposits, according to the FDIC's Statistics at a Glance. In December 2023, a full three quarters after the Fed paused its tightening of the Fed Funds Rate (QT continued), domestic deposits stood at $17.3 trillion. Nine hundred billion dollars, or 5% of deposits... gone. 

What happened?

Money market total financial assets, according to the St. Louis Fed, went from $5.2 trillion in total assets at December 2021 to $6.1 trillion in December 2023. Not so coincidentally, a $900 billion change.

Read this comment from M&T Bank Corporation's (MTB) fourth quarter earnings release:

"Net interest margin of 3.61% in the recent quarter narrowed from 3.79% in the third quarter of 2023 reflecting the higher costs paid on deposits amidst a continued shift of customer funds to interest-bearing products."

And indeed, MTB did grow deposits during this period. But the industry as a whole, not so much. Nationwide, depositors did switch to interest bearing accounts. But money market mutual funds seemed to be the benefactors of the switch. 

As far as community banks, I look to data gleaned from all of the banks where my firm does profitability outsourcing because we have a level of granularity that the FDIC and most readers do not have. Look at the two average balances per account charts below courtesy of The Kafafian Group.

It is true that the average balance per retail (non jumbo) CD account was higher in the fourth quarter 2023 than the fourth quarter 2021. But it was not materially so. In fact, if I multiplied the change in CD balances per account times the average number of CD accounts for all of our outsourcing clients, it would equate to a positive aggregate change in CD balances per bank of $65.7 million. For retail money market deposit accounts alone, the same math equates to an aggregate decline in those balances of $105 million. Of note there were 11% more CD accounts and 8% more retail money market deposit accounts. 

The outflow of deposits was not driven by a decline in the number of accounts. It was driven by the decline in the average balances of those accounts. The story is similar regarding business deposits (see chart above).

Although financial institutions cost of funds are now stabilizing yet still slightly increasing, it has been one year since the Fed paused its Fed Funds Rate tightening. This was similar to the tightening cycle between 2004 and 2006 when Fed Funds rose again to 5.25%-5.50%. But since the financial crisis came quickly on that cycle's heals, banks cost of funds rose two or three quarters after the Fed paused. Because the Fed then precipitously dropped the Fed Funds Rate to offset the negative economic impacts of the financial crisis. For this tightening cycle, the tail of increasing cost of funds amidst a Fed pause is lasting much longer. Higher for longer.

Most of our deposits are immediately callable. We believe we established relationships with our customers so they won't flee with every rate increase. A relationship is built on trust. And if our deposit strategy was to keep rates as low as possible so long as our depositors didn't notice, we have broken that trust. And they fled. Or we had to apologetically raise their rates to be closer to the market to keep their money. Something we continue to do.

What we can learn from this is there is value in a relationship, if we truly have a relationship where our depositors know our bankers and have someone to call to discuss banking matters. Some self-reflection might be needed here.

And secondarily, we have to assess the value of that relationship or other differentiated value we deliver. And by value I mean how much less than market deposit rates they will accept for that perceived value, which appears to be what they can earn in a money market mutual fund. Maybe it's 50 basis points. Maybe 100. But as we found out, it's not 300 or more.

Our cost of deposits will have to be managed by the strength of our differentiation and the mix of our deposits. Because this cycle proves that customers will flee. They may not close their account. But they will drain it. And we may not even notice it.

~ Jeff

Top 3 Jeff4Banks.com Blog Posts of 2023

I am always interested in learning what bankers and those that serve them are interested in reading. And since I have been writing industry articles and insights since 2010, clicks to my blog are a good indicator. Over the past two years I have been re-posting articles written here on LinkedIn. Usually a number of days after writing it. Prior to that I would put one or two paragraphs of the article on LinkedIn, followed by a link to Jeff4Banks.com. The new way lowers traffic to this site. But the number of clicks is directionally correct on what most interests readers.

The below top three are not necessarily from this year. In fact, the most read of 2023 was from 2013, ten years prior. Go figure?

Here were the top three most read articles of 2023:

Loan Pricing: Must It Be So Complicated

URL: Jeff For Banks: Loan Pricing: Must It Be So Complicated? (jeff4banks.com)

Publish date: September 6, 2013

Amazing that a 10-year old post rose to the top of the list. It is difficult for me to understand what resurrects an old article. Perhaps a web browser search. Perhaps a banker forwarded it around to their colleagues. Or perhaps there were a lot of bankers trying to improve loan pricing at their institution.

No matter the how, I'm pleased with the interest in simplifying loan pricing to account for the market, risk, and profitability of the individual loan. The next evolution of creating a culture of loan pricing discipline is to measure lender profitability by adding the spread of all the loans and deposits in their book, and assessing the cost per account times number of accounts. Then hold the head of commercial lending accountable for the continuous profit improvement of commercial lending products and the commercial lending line of business. That would be bottom-up accountability, which would inevitably lead to a more profitable financial institution.

One can dream.

Bankers: Please End This Practice. Or It Will End You.

URL: Jeff For Banks: Bankers: Please End This Practice. Or It Will End You. (jeff4banks.com)

Publish date: May 21, 2023

Prior to the Fed's quantitative tightening began in the first quarter of 2022 I was warning bankers that "a business model based on the sleepiness of your depositors is unsustainable." Before you accuse me of being Captain Obvious, know that I said this in 2018 during the prior Fed tightening cycle and before the pandemic. I felt so strongly about it that there is a chapter in my book about it, which I wrote in 2021. Again, prior to the 2022 Fed tightening. 

Does it make me happy that so many bankers read this article? Yes. Will it make me happier if bankers act on the recommendations or formulate their own funding strategies? Yes times two. 

Predicting the Next Banking Crisis Is a Fool's Game. Not Learning From the Last One: Equally Foolish

URL: Jeff For Banks: Predicting the Next Banking Crisis Is a Fool’s Game. Not Learning From the Last One: Equally Foolish (jeff4banks.com)

Publish date: June 2, 2023

This was an interesting top read as it was the speech I delivered to the general session of the New Jersey Bankers' Association annual convention at The Breakers in West Palm Beach, Florida. I might have looked stunned in the klieglights while delivering it but truth be told I saw my hotel room bill before delivering it. 

In my remarks I summarized lessons learned from each crisis since the S&L crisis of the late 1980's. And how each crisis was different than the last. There were themes worth noting, however. Credit risk, interest rate risk, and concentration risk have been part of every crisis. As an example, take the tech meltdown of 2001. This was a virtual non-event for the vast majority of banks because they had very low exposure to the tech sector. They were not concentrated in it. Fast forward to Silicon Valley Bank's exposure to startups funded by VC or P/E firms. That concentration cost them the bank.

There you have it. First a mea culpa: last year I only wrote 20 articles, far fewer than "content managers" tell me I need to keep the interest of readers. I write and research these articles myself (mostly). And they are time consuming, and I found myself with less time last year. I will try to do better for readers.

Thank you so much for reading my content. I welcome your questions, challenges, and even kudos. I love the kudos but I have thick enough skin to know my readers' challenges are to sharpen my opinions and help to move our industry forward.

~ Jeff