Banks trim cash, securities amid tight market for deposits

Higher deposit costs and a tough environment for deposit growth have pushed banks to increasingly ration liquidity and prioritize the most profitable client relationships.

Industrywide deposit outflows moderated during the second quarter. The result reflects banks' willingness to raise rates and compete with alternatives like money market funds. However, tight funding markets are weighing on banks' lending appetite and pushing them to trim buildups of cash undertaken after the failures this year and continue to reduce securities portfolios that had ballooned during the pandemic.

Total deposits notched a median 0.3% sequential increase in the second quarter among US banks that trade on major exchanges and reported results by Aug. 1, according to data from S&P Global Market Intelligence, as net interest margins (NIMs) fell by a median 17 basis points. Among the 25 biggest institutions by assets, cash declined by a median 4.1% and securities declined by a median 2.5% sequentially.

"Although deposit flows have largely stabilized in [the second quarter], we expect further deposit volatility, mostly in [demand account] balances," Jefferies analysts said in an Aug. 3 report. "Most banks are expecting balances to be flat-to-down in [the second half of 2023], with any growth likely to come at higher cost."

Growth at a cost

Deposits at domestically chartered banks declined by 0.9% industrywide from March 29 to June 28, a period that roughly corresponds with the second quarter, according to weekly data from the Federal Reserve. That was less than the drop of 3.0% from Dec. 28, 2022, through March 29, 2023, which roughly corresponds with the first quarter.

At the median increase of 0.3%, the publicly traded banks fared well in the second quarter, and the largest banks did better still — a group of 20 banks with assets of at least $68.53 billion posted median growth of 1.8% sequentially.

However, even among the big banks, growth came at a cost. First Horizon Corp.'s deposits increased 6.5% sequentially as it aggressively campaigned for new clients and bigger balances, and its NIM compressed by 47 basis points sequentially.

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Deposits at Truist Financial Corp. increased 0.3% sequentially as its NIM compressed by 23 basis points. The bank announced that it had unloaded a $5 billion student loan portfolio as it seeks to be more disciplined about how it competes and deploys capital. Like a number of other banks, Truist also said it is focusing on clients with broad relationships, as opposed to clients that only have a single product with the bank.

Less than half of respondents in S&P Global Market Intelligence's most recent US Bank Outlook Survey said they expect deposits to increase at their organization over the next 12 months. About 72.1% said they had increased their use of deposit rate specials over the last 12 months, and 56.8% said they expected to do so over the next 12 months.

Cutting cash and bonds

The sequential cash declines come as even some of the banks hit hardest by the turmoil earlier this year seek to pay off expensive wholesale funding.

Cash at domestically chartered banks shot up by $468.53 billion, or 27.5%, and other borrowing by $527.71 billion, or 49.7%, during the week that ended March 15, according to the Fed data, as banks sought to protect themselves from potentially violent swings in deposit portfolios. From March 15 through July 26, the most recent date available, cash levels had dropped back by $240.58 billion and other borrowing by $322.94 billion.

Banks have also continued to reduce securities portfolios, which had ballooned during the pandemic as deposits flooded into balance sheets and loan growth lagged.

Loans are generally higher yielding and more attractive assets than bonds, and banks have gravitated toward shorter durations amid an inverted yield curve.

"We expect securities balances to continue to decline for most banks as cash flows are likely to be used to support loan growth or held as cash," the Jefferies analysts said.