How Q2 bank earnings may affect 2021 deposit playbooks

Financial results from the first quarter of 2020 are mostly in, and no surprise there’s been a sizable  impact from COVID-19. Net earnings are significantly down, but in many cases this is mostly a function of choice as more cash is being redirected into Provision for Loan Loss (PLL) accounts.

Keep in mind that the majority of Q1 was behind us before we saw widespread lockdowns related to the novel coronavirus, so we can expect to see a different story in Q2. On May 1, CBS News cited a Black Knight study that mortgage forbearances jumped from 150,000 to nearly 4 million between March and April. Consumer loans, credit cards, private student loans and mortgages are all seeing a rapid increase in slow-pays and no-pays.

For now, banks are focused on doing what’s right by the customer and providing relief as best they can. Lessons were learned through the 2007-08 financial crisis about the value of customer advocacy, but as loan losses increase and tepid new loan bookings reduce interest income, financial institutions will look for aggressive cost-cutting measures to help right-size their income statements.

For the remainder of 2020, we can expect loan demand to be depressed and any return to normal life will be a challenge. For 2021, cost-cutting will likely be a directive for financial institutions, and expense savings will begin with the two biggest line items on the income statement: salary and benefits, and cost of funds. Both stand to have a major impact on the ability to efficiently gather deposits.

For the moment, a flight to safety in deposits is padding the production reports. We are seeing a significant increase in liquid deposit products for two reasons: first, customers want safety and flexibility in their deposits; and second, most banks do not have the capacity to open term deposits online. With branches closed or with limited operations, the ability of customers to open a CD at the local branch is a challenge. The liquidity of incoming deposits will make retention challenging as equity markets settle and consumers get back to normal.

In other words, we expect to see the ease of deposit gathering decline by the end of 2020. For most institutions, deposit gathering is still a branch-centric activity. This is problematic because as consumers have adapted to stay-at-home orders and adopted more technology, there could be less need for physical branches just as banks look to shed expensive branches and staff to cut costs.

A slimmed-down physical branch network will remove or inhibit a major deposit-growth engine for financial institutions and will likely come at a time when deposit gathering becomes more competitive. We expect the “easy deposits” – coming in as a result of increased savings rates among high earners (discussed in more detail in a recent blog post from Nomis economist Brian Poi) and from flight-to-safety refugees – to taper off by end of 2020.

By 2021, we expect to be back to creating targeted deposit offers and running specials (which cause cost of funds to increase). Commercial deposit “exception” pricing will likely make a return after being all but eliminated in the past two months. Next year will be a deposits strategy paradox – grow deposits to meet plan, but reduce cost of funding to meet expense targets. And all of this with a shrinking branch footprint.

As the saying goes, the best time to prepare for a crisis is when times are good, and the best time to prepare for a competitive deposit environment is while deposits are easy. By reducing deposit costs now, funds can be redeployed to install tools and practices that will put your institution at a competitive advantage while everyone else is catching up.

Dustin Allen is senior director of global deposit solution at Nomis Solutions

Register for “What Do We Do with Deposits Now?”, a BAI webinar on Thursday, May 21, featuring Dustin Allen of Nomis Solutions;  Chris Manderfield, KeyBank’s head of product management for the consumer segment; and Matt Smith, head of direct banking at Sterling Bank. The webinar will discuss deposit trends, where the industry is headed this year and how banks can set themselves up for success in the future.