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Small Bank Deposit Woes Continue

I have been a customer of Key Bank and JP Morgan Chase for a long time and have never had a savings account with either institution. The rates were never compelling and there were always restrictions or disincentives related to withdrawals.

Like many of our readers, money market products seemed to combine acceptable interest rates with daily liquidity and that was good enough. Recently the Fed has been increasingly underwriting yield and principal preservation (don’t break the buck) through its $2.2 Trillion Repo facility available to money market providers. The rates on many money market offerings are 3- 4% with an implicit government guarantee.

It surprised me when I received a call from an account officer at Chase Bank last week asking me if I would be interested in putting a portion of my checking account in a savings account with a 4% interest rate and daily liquidity. As I started thinking about it, I could not understand how Chase could make that offer?

It turns out that Chase and its brokerage arm, JP Morgan, have designed a brokerage product linked to the Chase checking account where JP Morgan invests in a vehicle that is either hedged or pooled fixed income. Somehow the product also carries the $250,000 FDIC government guarantee even though the deposit resides at JPM, and you have to manage liquidity through a registered representative of the brokerage arm, not a bank officer. So, it is really an FDIC insured savings account with daily liquidity and a 4% fixed rate custodied at and administered by JPM.

Competition For Deposits Includes New Actors

Additional competition for deposits just surfaced last week when Apple recently announced it would offer 4.15% APY for its Apple Pay cardholders under an arrangement with Goldman Sachs. The product is a savings account with FDIC insurance up to $250,000 as well as providing daily liquidity. That Apple Pay rate is higher than Goldman pays for its own Marcus savings account right now.

These compelling products come at a time when commercial banks have become used to demand deposits paying almost no interest, savings accounts paying less than 1% and certificates of deposit offering between 1 and 3 percent depending on maturities.

In light of the beginning of a small bank deposit migration after Silicon Valley Bank’s failure I began to wonder how the low end of the US banking market can compete with larger institutions who can use a brokerage arm and capital markets to offer a 4% savings account? How can the asset base at these smaller banks generate the net interest margin to afford a guaranteed 4% savings account? I reached out to several friends who are specialists in the small bank market, and they point to the Apple Press release, the Fed’s repo facility underpinning money market accounts yielding 3-4%%, and inverted yield curve where a 6 month T-bill pays 4.6%%. In essence, the small banks don’t have a choice about raising deposit rates.

According to Ben Mackovac who is a principal with Strategic Value Bank Partners, an investment fund specializing in small bank special situations, small banks are moving quickly to offer competitive deposit products with rates as high as 4 % and quality loans at 7%-8% but he admits this dramatic adjustment in the formula for an acceptable net interest margin will take time.

Past Is Not Prologue

A recent Wall Street Journal article written by Telis Demos on April 28 titled “Regional Banks’ Deposit Remix Not as Good as the Original” Regional Banks’ Deposit Remix Not as Good as the Original (click on link to read) suggests that these products will pull deposits from smaller institutions. The average rate on a bank savings account is 0.29% so these new products are 15x better. In an earlier Wall Street Journal article written by Gina Heeb on April 16, 2023, titled “Banks Are Finally Facing Pressure To Pay Depositors More”, Ms. Heeb points to the rapid escalation of interest rates after decades of rates descending to zero, and in some cases, negative rates:

Deposit rates on standard savings accounts have inched up over the past year. The average rate paid on deposits at banks and credit unions was 0.37% in March, according to the FDIC, compared with 0.06% a year earlier. But rates have moved faster on deposit accounts designed to keep money parked for longer periods. The average yield for online savings accounts rose to about 3.75% in March, according to indexes from Deposits Online LLC, compared with 0.5% a year ago. Online one-year certificates of deposits on average offered an annual percentage yield of nearly 4.75%, up from less than 1% in 2022. 

The old joke about the senior banker educating the junior bank officer was “you only need to know the numbers 2, 5 and 1 to be successful in the banking industry.” The junior banker replied, “well I know that 2 is the average rate of interest we pay for deposits and 5 is the average rate we loan that money out to customers but what is 1?” The senior banker replies, “1 is my tee time at the country club.”

With the double whammy of balance sheet write downs due to bank assets yielding less than current market rates and the cost of deposits being 15 times higher than they were 18 months ago the new numbers for this joke during  transition may be 5, 5 and 0, with ZERO representing both the bank’s net interest margin and the number of times any banker may have a tee time at the golf club this summer.

The above commentary is for informational purposes only. Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records. Founder and chairman of CW Industrial Partners (originally CapitalWorks, LLC), he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CW Industrial Partners or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.