US banks increasing reliance on CDs as funding pressure builds

US banks continue to rely on expensive borrowings such as certificates of deposits (CDs) and are being forced to offer higher rates in order to protect against outflows as customers seek greater returns.

In the aggregate, CD balances at publicly traded banks increased 30.6% quarter over quarter for those that have reported second-quarter earnings as of July 21, according to S&P Global Market Intelligence data. For a number of institutions, the balances are jumping significantly off a relatively low base. During second-quarter earnings presentations, 50% quarter-over-quarter increases were reported by at least 11 banks, namely Associated Banc-Corp, Bar Harbor Bankshares, Comerica Inc., Commerce Bancshares Inc., First Horizon Corp., Glacier Bancorp Inc., Nicolet Bankshares Inc., Oregon Pacific Bancorp, Plumas Bancorp, Webster Financial Corp. and Zions Bancorp. NA

The cost of the products has also been climbing. The average interest rate on one-year CDs increased by 15 bps to 1.98% from the May 3 rate hike to July 7. The average rates have increased by 70 basis points since year-end 2022 and by 33 basis points since the failure of Silicon Valley Bank on March 10.

Continued funding pressures will lead to thinner margins

Deposits costs are likely to remain elevated throughout 2023, in no small part due to the continued growth in high-cost CDs. The buildup in higher-cost products will lead to higher funding costs and should serve as a headwind to net interest margins.

Large time deposits at domestically chartered US banks have increased by 24.3% between March 29 and June 28, according to seasonally adjusted data in the Federal Reserve's H.8 report on bank assets and liabilities. The 25 largest banks saw an increase of 31.9%, while the small banks saw them grow by 17.3%. Total deposits declined by 2.4% during the same period.

As of March 31, the CD balances at US banks stood at $2.132 trillion, up 24.8% from the previous quarter, crossing the $2 trillion mark for the first time since the onset of the COVID-19 pandemic.

In the first quarter, the concentration of CDs to total deposits was up 513 basis points since the Fed began raising interest rates in 2022 to 11.4% and is the highest since the first quarter of 2020.

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During the first quarter, more than 3,700 banks saw increases in their CD balances, overshadowing the combined $14.88 billion decrease among 884 banks reporting lower balances in the deposit product.

Only two banks among the largest 25 by assets, Citibank NA and Goldman Sachs Bank USA, had quarter-over-quarter decreases in CD balances. Citibank recorded a decline of $1.53 billion, while Goldman Sachs posted a $3.91 billion decrease.

Federal Home Loan Bank advances jumped 37% to $804.69 billion, representing 3.8% of total liabilities compared to 2.7% at year-end 2022.

Deposit competition heating up

The Federal Reserve's rapid increase in rates to curb inflation has resulted in elevated funding pressures as customers move deposits into higher paying accounts. At the end of the first quarter, deposits had declined by 4.9% since the end of 2021, and interest-bearing deposits rose to 75.2% from 71.1% of total deposits five quarters ago.

Many banks have responded to the shift in customer behavior and have sought to retain those customers by marketing CDs at higher rates. As of July 7, the number of banks offering rates over 4% on one-year CDs have more than doubled to 524 since the failure of Silicon Valley Bank. These banks held 21.4% of the industry's assets at the end of the first quarter.

PacWest Bancorp was among the companies with the highest increase in CD concentration in the first quarter, with CDs to total deposits growing 10.6 percentage points to 24.6%. The company has been actively restructuring its balance sheet since facing pressures in the market in the aftermath of several large bank failures.

Amid the shift in funding mix, the Street has lowered its expectations for PacWest's net interest margin. Since the year-end, the 2023 consensus net interest margin estimate for the company has been revised downwards by 133 basis points to 2.34% as of July 13.

Only 17 banks with at least $500 million in CD balances as of March 31 reported a quarter-over-quarter decrease in CDs to total deposits concentration. Among these was First Citizens BancShares Inc., with its CD concentration declining 2.5 percentage points to 9.5% of total deposits.

First Citizens purchased the majority of the assets and liabilities of Silicon Valley Bank. According to Form 8-K filed March 27, the company acquired approximately $56.5 billion of Silicon Valley Bank's deposits, of which 63% were noninterest-bearing demand deposits. The company's noninterest-bearing deposits to total deposits jumped to 39.1% as of March 31 from 27.8% at the end of 2022.