Community banks continued to face high funding costs in the second quarter, with the 20 largest by total loans all seeing deposit costs rise year over year.
With the Federal Reserve's rate cut in July, the first in roughly a decade,
Dallas-based Veritex Holdings Inc. is one community bank where deposit costs have begun improving.
"We have seen our overall deposit costs drop since [June 30]," Chairman, President and CEO Charles Holland III said in an interview. The bank saw year-over-year deposit growth above 100% in the quarter due to its acquisition of Houston-based Green Bancorp Inc., which closed in the third quarter of 2018. Organic loan and deposit growth was in the mid-to-high single digits, the CEO said.

With one Fed rate cut so far this year and more expected, the question is no longer whether deposit costs will fall elsewhere in the industry but how long that will take, said Catherine Mealor, a bank analyst with Keefe Bruyette & Woods.
"You're going to see a lag," she said in an interview.
Competition for deposits is still strong, even with lower rates, Holland said. "We deal with competition in both community banks and also with superregionals. It's still hand-to-hand combat every day on the deposit side."
Some banks are using "irrational" deposit pricing strategies, setting rates high enough to be unprofitable, in order to out-compete peers, he said.
Curt Long, chief economist and vice president of research at the National Association of Federally Insured Credit Unions, said that competition is increasing in the credit union space as well, driving up the costs of deposits even as the rate environment begins to soften. "We are seeing some pockets of rising cost of funds for some credit unions," he said.

The increasing trend of credit unions purchasing banks has not typically been driven by a hunt for lower-cost deposits in particular, Long said.
"There are just some credit unions that are interested in growth," he said. "It's an environment where there's a lot of pressure to increase scale, and I think credit unions and community banks feel that pressure similarly."
Loans have grown faster than deposits in recent years, experts said, allowing banks and credit unions to better manage their margins. Loans grew faster than deposits in the second quarter on a median basis at credit unions, but some are starting to see a slowdown in auto lending, said Long. If rates continue to fall, though, some buyers could reenter the auto market.
"Whether lower interest rates push people back into [the auto] market and help to expand the credit union auto loan portfolio — that's a question we have going forward," Long said.

Having higher loan-to-deposit ratios limits flexibility in funding but often makes banks more efficient, said KBW's Mealor. "You have a lot of pressure in that you have to fund every dollar of loan growth with a new dollar of deposit growth, and when rates are rising, that can be challenging to your margin," she said.

So far, banks and credit unions have been able manage their margins. "Most banks are some form of asset sensitive," Mealor said. "There is still an ability to increase loan yields to where we saw some nice margin expansion."
Long views the credit union space similarly. "They've shown good management of their net interest margin through this period," he said.
