A Tale of Two Banks: Stories From the Battle for Liquidity, Part 2

Even before headlines reported the recent commercial bank failures, last year's series of interest rate hikes already had bankers focused on growing deposits, protecting the deposits they already have, and stepping up loan loss provisions. In this three-part blog series and accompanying webinar on June 7, we examine Q2 PrecisionLender's proprietary data to reveal stories of what's going right—and what could go wrong—in the chase for deposits.

In Part 1 of this look at A Tale of Two Banks, we focused on an amalgamation of Q2 PrecisionLender clients that had successfully weathered the high interest rate environment and experienced deposit growth between September 2022 and February 2023—our targeted time frame for this research. During this period, Q2 PrecisionLender clients’ deposit portfolios showed that 40% of the financial institutions saw an increase in balances, approximately 40% saw a decrease in balances, and the remaining FIs saw no change.

In Part 2 of this story, we’ll focus on the 40% of Q2 PrecisionLender clients that saw a decrease in balances during our specified time frame. We pulled data from several FIs—which we’ll call the contraction group—to frame a picture of contracting deposit balances and what additional impacts this attrition may have on relationship banking leading into March 2023. 

As a reminder, the deposit pictures in Part 1 and Part 2 of A Tale of Two Banks come from deposit accounts assigned to commercial relationship managers at their respective FIs. These are not house accounts. Once again, we’ll focus on the same areas: 

  • Deposit rate paid movement and sensitivity (beta) 
  • How institution leadership values deposits through the Funds Transfer Pricing (FTP) credit
  • Sources of deposit inflows     

A Picture of Contraction  

For the bankers in the deposit contraction group, we found that price sensitivity of the deposits and the underrepresentation of non-interest-bearing demand accounts frame the challenging environment these bankers face.  

To begin, the contraction group is similar to the deposit expansion group we portrayed in Part 1 of A Tale of Two Banks in that a few bankers carry the predominance of deposit balances. Here, the top 5% of bankers hold 29% of the balances. (In the expansion group, the top 5% of bankers hold 37% of the balances.) The similarities end there.  

Within the contraction group, the rate paid measure for the top bankers is higher at 2.28% overall than the remainder of the distribution at 1.01%. The expansion group of bankers did not compete on price to hold deposits to the same degree. 

Distribution of Bankers by Deposit Balance and Rate Paid

We also examined the rate of change on the interest rate paid for deposits across the groups we studied to demonstrate how quickly performance can deteriorate in this environment. For the bankers in the deposit contraction group, the rate paid was higher than that of the overall FIs for that group. Those bankers began from a higher deposit cost and moved relatively higher during the period. We noted in Part 1 that the expansion group demonstrated a very low beta by comparison. Of course, not all deposit books are created with similar sensitivities to interest rate changes.

We found similarities in the concentration of deposits with bankers; however, the similarities separate into distinctions quickly. The top 5% of the contraction group’s bankers paid 2.28% cost of funds compared to the remainder at 1.01%—a difference of 127 bps. The expansion group showed a variance of only about 50 bps, with the top group at about 1.00% and the remainder of the bankers at 1.50%.  

Overall Deposit Rate Paid Percentage (Cost of Funds)

Next, we compared the relationship composition change for both groups and found that the high beta (rate paid) of the contraction group did not stave off deposit attrition.

Relationship Composition Change, Indexed to September 2022 = 100

During this time, the contraction group saw erosion in deposit balances and net income, as well as relationship attrition. Loan balance composition held at par. In sum, fewer deposit balances and relationships push total book performance lower, measured by a 20% decline (index value of 80) and nearly equivalent for net income.    

Importantly, the expansion group expanded its interest-earning asset base through loan balance growth. It added deposit balances and relationships. Total net income increased to an index of 120, and average relationship performance increased. 

We note further that deposit accounts and balances, along with their net income, can move freely across FIs. For the contraction group, the movement has been sharp and swift. On the other hand, loan facilities seem to be less free to move across FIs based on our analysis. The comparison of the loan-to-deposit balances between these two groups is telling and may place pressure on incremental loan growth across the contraction group FIs.

Loans to Deposits, February 2023

Moving beyond rate paid on deposits as a key driver of performance, we examined product mix within the contraction and expansion groups. We found a significant underrepresentation of non-interest-bearing deposit balances, at 2% compared to 73% for the expansion group. In Part 1 of Tale of Two Banks, we observed that groups of bankers within the portfolio face different circumstances. The contraction group FIs show a 10% concentration of non-interest-bearing deposits. For the entire Q2 PrecisionLender client base, this measure is approximately 37%. The expansion group FIs post about 50%. 

The contraction group has a significant product mix disadvantage while the expansion group has a significant product mix advantage to help drive sustained value during this time frame. We all know the importance of anchoring deposit-generating relationships with the primary operating accounts of the business as a cornerstone of success. In this post, we shed light on and quantify this importance in a time of interest rate movement and provider choices. This cost, measured by these cases of expansion versus contraction, has been large and rapid for the lack of this foundational non-interest-bearing layer. Where deposit growth is possible and desirable mix is available, attracting one’s fair share is a priority for sound liquidity management.

Because the contraction group lost deposits and some relationships along with them, it is not surprising that loan growth suffered, as well. Overall, the rate paid sensitivity is high on an absolute level as well as compared to the overall FIs and the expansion group.

Overall Deposit Mix

Deposit valuation comparison shows that the contraction group and the expansion group both increased their respective FTP credit rates during this period. The expansion group moved up 63 bps versus the contraction group, which moved up 43 bps. From the banker perspective, however, the high beta rate paid for the contraction group waterfalled to a loss of value in those bankers’ books of business—71 bps during this period. It appears that, among the contraction group, deposit retention and acquisition may not be fully integrated into the liquidity strategy.

Change in Deposit Rate Paid Waterfalls to Deposit Value

It's Not All Bad News

There are some successful behaviors among the contraction group. We found high inclusion of deposits added to new opportunities, as well as above-average pricing activity per banker. These bankers clearly have opportunities to pursue. We also noticed a lesser-managed pipeline for the contraction group.

Selected Pricing Activity Metrics

It Starts at the Top

As it did for the deposit expansion group, our research revealed some common themes for the contraction group: 

  • Strategically, monitoring deposit onboarding through the Delivery to Promise feature in Q2 PrecisionLender is a powerful component. The contraction group does not have the same pipeline management discipline as the expansion group; therefore, Delivery to Promise is handicapped as a measurement tool.
  • Pipeline management is hindered by a lack of integrated systems.
  • Poorly communicated approval processes and workflows inhibit banker empowerment.
  • Focusing incentives on easy-to-reach loan targets can often discourage deposit conversations. 
  • Deposit valuation goes beyond the ALM/Treasury value source of funding, and deposit rate/flight sensitivity can have harmful impacts on interest-earning assets and overall performance.      

Strategies to secure and expand core deposit operating accounts could not be more valuable. Wrapped into the consumption of services these accounts have is the offsetting measure of earnings credit rates. This is a dynamic environment in 2023 after a long period of stable ECR.  ECR and service calculations are key in securing the operating account that works for the depositor.  With Q2 Premium Treasury Pricing, relationship managers and treasury officers can collaborate using a single pricing and profitability platform from the start of a deal, which encourages more effective cross-sell with relationship-based pricing.

The results of our research shine a light on why strategic agility and deployment, including an emphasis on primacy, product mix, competition based on relationship-level value, execution discipline, properly aligned and measured incentive plans, and the effective use of the right tools can make a massive difference in the current environment.

Get More Insights at Our Upcoming Webinar

Join Q2 PrecisionLender experts on June 7 from 2 to 3 p.m. ET for more insights about the findings from this research. 

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Commercial Loan Pricing Update (April 2023)
Commercial Loan Pricing Update (April 2023)

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A Tale of Two Banks: Stories From the Battle for Liquidity, Part 1
A Tale of Two Banks: Stories From the Battle for Liquidity, Part 1

In the first of a three-part series, we explore how deposits changed from September 2022 to February 2023 f...