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US banks reduce reliance on CDs, but rates significantly lag Fed rate cuts

While certificates of deposit continue to become smaller portions of U.S. banks' funding bases, the rates on the products have not fallen as quickly as some would have hoped.

In the third quarter, CD balances increased 9.8% from year-ago levels. Until very recently, banks had become more reliant on CDs for funding, growing the concentration of those products fairly steadily in recent years. CDs fell to 14.39% of total deposits across the industry in the third quarter from 14.65% in the prior quarter.

The rates offered on the products have fallen notably in the last five months, but the declines have significantly lagged the trio of rate cuts by the Federal Reserve. Even with decreases in rates, CDs remain relatively expensive deposits, particularly when compared against the drop in loan yields. While earning-asset yields have fallen, the cost of interest-bearing deposits actually rose 1 basis point in the third quarter, in part due to the prevalence of higher-cost CDs.

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Banks with assets between $3 billion and $10 billion have decreased rates the most on one-year CDs, perhaps the most popular products. Among those institutions, one-year CDs with minimum balances of $10,000 dropped 6 basis points between Nov. 29 and Oct. 25, just days after the last rate cut by the Fed. The decrease in the rate on one-year CDs among those banks is double the 3-basis-point decrease offered by the broader banking industry during the recent one-month period.

Since late June, rates on one-year CDs have fallen much more, declining 21 basis points among banks with $3 billion and $10 billion and 12 basis points across the industry.

However, rates on those products have not declined that much when compared with the level seen near the end of 2018. Among banks with assets between $3 billion and $10 billion, rates on one-year CDs have declined only 15 basis points since Dec. 28, 2018, but have fallen only 4 basis points across the industry. During the same period, the target fed funds rate has plunged 75 basis points.

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Looking at one-year CDs with a minimum balance of $10,000, 162 banks cut rates by more than 75 basis points since late December 2018. The top 50 institutions in that group decreased rates on those products in the range of 110 to 225 basis points.

Some bankers have expressed greater optimism toward their ability to lower CD rates in 2020. Synovus Financial Corp. Chairman and CEO Kessel Stelling Jr. noted on the company's third-quarter earnings call in late October that CD pricing remains competitive, but origination levels were roughly 30 basis points below maturing CDs, on average.

Flushing Financial Corp. President and CEO John Buran said on his company's third-quarter call that its cost of funds began to decline late in the period. He said the average cost of new CDs was less than 2%, and the company has close to $1 billion in retail CDs maturing before the third quarter of 2020 at an average rate of 2.33%.

Not surprisingly, rates on longer-dated time deposits have decreased the most thus far, given that those products tend to more closely mirror long-term benchmark interest rates like the 5-year and 10-year Treasury notes. The yields on both of those instruments have plunged in 2019, each falling nearly 100 basis points year-to-date.

Small banks remain the most reliant on CDs for funding and saw the products become larger portions of their funding bases in the third quarter. During that period, the median composition of CDs to total deposits rose to 29.6% at banks with less than $3 billion in assets, from 29.1% a year ago.

The median CD composition rose across all asset groups, save for banks with assets between $10 billion and $50 billion, where the products declined to 16.6% of deposits from 17.3% a year earlier.

However, when focusing on individual institutions across the industry that reported the greatest increases in exposure to CDs, slightly more than half were community banks. Among the top 20 institutions with at least $3 billion in assets reporting the largest increase in CD reliance for funding, 12 had assets below $10 billion.

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