Our on-going analysis of the deposit dilemma shows some good news for community and regional banks, based on 2019 third-quarter data. But trouble still looms.

Overall, community and regional banks showed signs of life for the first time in nearly two years in the transaction account markets.  If this indicates a trend, it will certainly help community banks better manage their cost of funds.  But if deposit growth does not accelerate – even though it picked up in the third quarter – community banks will face continued vulnerabilities.  Low loan growth and a pause in Federal Reserve monetary policies do not provide a great recipe for deposit growth moving forward.

The first half of 2019 saw weak deposit growth—just $100 billion of net new deposits. The third quarter, however, saw total grow by $232 billion, the biggest increase since the fourth quarter of 2018.  Whether it’s a one-time blip remains to be seen.

But our deeper dive into the movement of deposits reveals some interesting patterns in the third quarter.

1. We finally have some decent growth in transaction accounts again – even for community banks. Transaction accounts, the highest quality and least expensive form of deposits, grew by $54 billion in the quarter and account for 24 percent of total deposit growth.  Although we have seen transaction accounts grow, albeit meagerly, since the end of 2017, nearly all that growth benefitted the Top 4 banks.

Banks of all sizes were a winner in the third quarter of 2019, with each tier recording gains in transaction accounts. In fact, the Top 4 banks eked out the smallest gains in the quarter, despite their recent dominance.

Despite the growth in transaction accounts, community and regional banks did not grow enough to maintain their market share. This is concerning because if this quarter’s results hold steady, community banks appear to be dependent on growth of the entire pie to grow their own deposit slice. In other words, they will lose in a zero-sum game, as previous quarters indicate.

As a side note, the growth of the $50 billion to $500 billion asset group jumps off the page. These banks dominated the quarter by winning 74 percent of the net new transaction accounts up for grabs, even though they only had 26 percent of all transaction accounts at the end of the prior quarter.  Below is a list of the top 10 winners of transaction accounts in the third quarter, with all but one of them (Wells Fargo) coming from this asset-sized group:

I am not sure what explains the dominance of this group, but I do find it interesting that the banks ranked numbers 2, 3 and 4 (State Street, BONY Mellon and Morgan Stanley) are investment houses, not traditional commercial banks.

3. Money market accounts represented a whopping 69 percent of total deposit growth. In other words, of the $232 billion of total deposit growth previously mentioned, $160 billion of it came from money market accounts.  Money market accounts grew at a disproportionate rate in the third quarter; they only represented 42 percent of all deposits at the end of the second quarter.

Community banks continue to rely on MMDAs more than usual to drive deposit growth, relative to historical percentages. This was especially true for banks with assets between $10 billion and $50 billion, which relied on MMDAs to drive 75 percent of their deposit growth even though they represent only 42 percent of deposits historically, as the chart shows. The same can be said though for the Top 4 banks, although Citibank accounts for $50 billion of MMDA growth on its own.

Many bankers I speak with are talking about the increasing competition to win MMDAs.  Unlike CDs, MMDAs do not have a maturity date, so community banks need to be careful about paying so much for MMDAs that they approach CD rates, yet without their benefits.

4. Savings accounts and retail CDs had mixed results but were generally out of favor. For the last 18 months, these two deposit product types, which in many ways go together with a similar customer base, were generating strong growth, especially for the large regional banks ($50B-$500B in assets). Banks with strong digital platforms and heavy advertising spend such as Capital One, PNC, Goldman Sachs (via Marcus), and Ally generated strong gains in market share over this period.

However, growth in these accounts came to a grinding halt in the third quarter.  Savings accounts finished a distant third to MMDAs and transaction accounts and Retail CDs declined.

I should mention that the $1 billion to $10 billion asset-size group of banks outperformed the industry in the savings account market.  This group won $10.1 billion, or 51% percent of net new savings accounts in the third quarter.

It is likely that the impact of the Fed’s rate cuts started to tweak depositor behavior.  High yield digital offerings on both savings accounts and retail CDs are less attractive than they were at the beginning of the year and prior to this recent rate cut cycle.

5. Community banks were far more likely to experience an increase in their cost of funds versus larger banks. Despite having two rate cuts at their backs (lag aside), community banks (74% of banks with less than $1 billion in assets, and 63% of banks with between $1 billion and $10 billion in assets) saw their cost of funds increase in the third quarter.  On the other hand, all four money center banks and most regional banks saw their cost of funds decrease.

The Top 4 banks, each with a loan-to-deposit ratio well under 70 percent, are not reaching for deposits and competing on price.  They are also not making many loans and will be patient as they execute their branch expansion plans to help them offset the impact of QE reversal and comply with the Liquidity Coverage Ratio.  On the other hand, the increasing dependence on highly competitive MMDAs by community banks will likely continue to prevent their cost of funds from material improvement.  As long as there are community banks that exist with uber high LTD ratios well in excess of 100 percent, there will be banks in the market offering aggressive pricing on MMDAs, even though the Fed has now delivered a third rate cut.

To wrap it up, the third quarter numbers bring some hope to community banks. But they continue to remain vulnerable if overall deposit growth does not accelerate.

— Adam Mustafa is the CEO of the Invictus Group.