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US banks reduce reliance on CDs, push for further declines to defend margins

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US banks reduce reliance on CDs, push for further declines to defend margins

After years of increasing, certificates of deposit became smaller portions of banks' funding bases in the second quarter, and recent decreases in interest rates suggest the trend could continue.

In the second quarter of 2019, CD balances increased by 15.1% from year-ago levels. Until very recently, banks had become more reliant on CDs for funding, growing the concentration of those products fairly steadily over the last five-plus years. But that changed in the second quarter, as CDs fell to 14.65% of total deposits across the industry from 14.77% in the prior quarter.

The rates offered on the products have also begun to decline, albeit modestly, in the aftermath of rate cuts by the Federal Reserve. CDs still represent relatively expensive deposits, particularly longer-term products, when compared to other forms of funding, especially when considering the recent declines in both short-term and long-term rates. Those higher-priced products can eat into bank profitability, while floating-rate loans reprice lower and newly originated credits come onto bank balance sheets at lower yields.

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Against that backdrop, a number of banks have reduced their expectations for net interest income and now believe net interest margins could decline. Many banks are working to mitigate that risk by trying to lower their funding costs, in part through reductions in their CD books.

Associated Banc-Corp President and CEO Philip Flynn said at an investor conference earlier this month that the company is working hard to reduce higher-cost funding. The executive said the company reduced network transaction deposits by $400 million in the second quarter and decreased CDs by about the same amount. Flynn said he expects the company to reduce network deposits and higher-cost CDs by another $500 million in the third quarter.

Other bankers believe they will receive some relief later in 2019 and in 2020 as deposits such as higher-priced CDs reprice. Huntington Bancshares Inc. CFO Howell McCullough said at an investor conference that the company has an $8 billion repricing opportunity in the second half of 2019 between CDs that are maturing and money market special rates that are expiring.

Many banks similar in size to Huntington — institutions with assets ranging from $50 billion to $250 billion — continued to increase their reliance on CDs the most, with the median concentration rising to 16.7% of deposits from 13.7% from a year earlier.

However, when focusing on individual institutions across the industry that reported the greatest increases in exposure to CDs, most were community banks. Among the top 20 institutions with at least $3 billion in assets reporting the largest increase in CD reliance for funding, 17 had assets below $10 billion.

Still, most institutions, including community banks, have decreased CD rates in the nearly two months since the Federal Reserve cut rates in late July. 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 8 basis points between July 26 and Sept. 13. The decrease in the rate on one-year CDs among those banks is double the 4-basis-point decrease offered by the broader banking industry during the recent two-month period.

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The market had expected the Fed to cut rates again in the months that followed that period, and the central bank delivered with another 25-basis-point rate cut on Sept. 18.

Looking at one-year CDs with a minimum balance of $10,000, only 65 banks cut rates by more than 50 basis points. The top 50 institutions in that group decreased rates on those products in the range of 60 to 192 basis points.

Not surprisingly, rates on longer-dated time deposits have decreased even more, 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, falling nearly 100 basis points each year to date. In the last two months alone, the yields on both securities have fallen close to 40 basis points.

However, rates on longer-term CDs have declined by far smaller amounts through mid-September. The average rate on three-year CDs with minimum balances of $10,000 fell 7 basis points across the industry. The average rate on that product fell at banks of all sizes, but they declined the most among banks with assets between $50 billion and $250 billion in assets. Those institutions still market considerably lower rates than their smaller counterparts.

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