Pub. 14 2017 Issue 1

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G N E W M E X I C O R E A L I Z E D R E A M S 16 The Environment for Bank Funding & Deposits in 2017 By Glenn Martin Regional Director, Promontory Interfinancial Network W hen it comes to funding and deposits, bankers are in a similar position to where they were 12 months ago. Just as it did at the end of 2015, the Federal Reserve decided to raise interest rates at the end of 2016, and now bankers face the question of what the funding future looks like. According to the early November re- sults from Promontory Interfinancial Network’s Bank Executive Business Outlook Survey—a quarterly survey that captures the expectations of bank CEOs, CFOs, and presidents on a range of eco- nomic and industry subjects—most bank leaders expect to see moderate growth in funding costs over the next year. Despite the possibility that an increase in interest rates could impact bank net interest margins, bankers awaited the interest rate increase at the end of 2016 with some enthusiasm, just as they did at the end of 2015. One reason for the general enthusiasm is that banks have been preparing for this for a while. Concerns about interest rate risk appear to be a thing of the past. The general expectation by bankers for an increase in funding costs has been consistent for more than 18 months, and bankers have been positioning their funding portfolios to dull the margin im- pact of a rise in rates accordingly. Asked to assess current and target funding durations, survey respondents indicated little difference between the expected duration of current funding sources and the duration of the funding that they are targeting going forward. Now, with ratesmoving once again, what is the impact that banks can expect to see? Even the single rate increase at the end of 2015 led many bankers to experience a notable shift in the cost of their banks’ funding in 2016. Nearly 40% of bankers that responded to the BankExecutive Busi- ness Outlook Survey in November 2016 reported that they had seen an increase in their funding costs over the past 12months. With the December 2016 rate hike, it’s pos- sible that higher funding costs will become the experience for a majority of bankers. This could create greater issues for banks than in previous rising-rate cycles. Loan-to-deposit (LTD) ratios are still well below pre-crisis median levels at the country’s biggest banks. According to Call Report data, LTD at banks with more than $250 billion in assets is at 76%, well below the pre-crisis median of 98%. As these large banks continue to grow their assets, eventually they may need to push further into the deposit market, potentially driving funding costs upward. A deposit push from big banks may be a particular concern for community banks that currently hold a substantial amount of surge deposits, which have settled in banks awaiting yield from whoever is willing to offer it. LOOKING BACK TO LOOK AHEAD So what can banks expect to happen in 2017? Given the similarities between the end of 2015 and the end of 2016, it’s useful to consider recent history and how 2016 deviated from expectations with respect to the funding side of the balance sheet. In the Q4 2015 edition of the Bank Ex- ecutive Business Outlook Survey, which was taken in January 2016, nearly 40% of respondents indicated that their funding costs had worsened. That was double the percentage of respondents that had ex- perienced higher funding costs just one quarter prior. And expectations were high that in- creases would continue. More than 70%of respondents to the January survey report- ed that they expected to see their funding costs rise in the 12 months following the survey. Expectations were similar in the April edition of this same survey. Then came a substantial shift. In the Q2 survey, taken in the final two weeks of July, there was a notable drop in ex- pectations for a funding cost increase. By this time, barely half of all surveyed bank leaders expected to see an increase in funding costs over the coming year.