Banks are cutting their higher-cost funding as they take advantage of historic deposit growth.

Deposits have continued to surge into the banking system in 2021, building on the explosive growth recorded during 2020. Loans, meanwhile, have actually contracted since the end of 2020, leaving institutions sodden with excess liquidity. The industry's loan-to-deposit ratio plunged even lower in the first quarter of 2021, falling below 60%. The lackluster loan growth and low interest rates have pushed net interest margins to record lows. Banks have tried to mitigate the pressure by lowering the yield they pay on funding such as high-cost certificates of deposit and also by reducing their reliance on higher-cost CDs and borrowings for funding.

The concentration of CDs and borrowings on bank balance sheets both continue to reach new record lows. CDs decreased 6.6%, or $100.65 billion, quarter over quarter across the industry in the first quarter of 2021, falling to 7.7% of total deposits from 8.5% in the fourth quarter. Borrowings continued to decline at an even faster pace, decreasing 9.6% from the linked quarter to just 1.1% of liabilities.

Over the last three quarters, banks' holdings of CDs have declined by more than $400 billion.

Some banks have continued to extinguish borrowings early, recognizing their reduced liquidity need due to the influx of deposits. More banks could follow suit as excess liquidity continued to build after the first quarter of 2021. The Federal Reserve's H.8 data, which tracks commercial bank balances, shows that deposits have grown 6.2% through the week ended June 16 since Dec. 30, 2020. Meanwhile, loans declined 0.5% over the same period.

Smaller banks continue to be more reliant on higher CD and borrowing balances than larger banks, but some have used excess liquidity to decrease their concentration of CDs. Other banks say they are simply looking to reduce rates on CDs while retaining customers.

Synchrony Financial, which counts CDs as 46.0% of its deposits, found there is a floor to just how low CD rates can go before pushing away customers. Synchrony CFO Brian Wenzel Sr. said during an investor conference in early June that the company tested how much it could lower CD rates. Wenzel said the company looked at the difference between digital online rates and brick-and-mortar rates and was the leader in lowering CD rates down to within 40 basis points of the rates offered through physical branches. The executive said that most other institutions followed but some held rates at 50 basis points higher than those offered through physical branches, and Synchrony began to see attrition.

"What you don't want to see is your core deposit people starting to rotate dollars out," Wenzel said. "We've kind of tested that floor. It appears to be 40 or 50 basis points difference between there and the brick-and-mortar."

Other banks note that CDs set to mature in the second quarter of 2021 should reprice significantly lower. Sterling Bancorp Inc. (Southfield MI) CFO Stephen Huber, for instance, said during the company's first-quarter earnings call that roughly one-third of its CD portfolio will mature in the second quarter. Huber said a significant amount of those deposits are 12-month CDs with rates in the range of 1.35% to 1.45%, and the company expects them to reprice at around 25 basis points, assuming the customers choose to remain with the bank.

Across the industry, the average rate on one-year CDs has fallen 22 basis points over the last year to 0.28%, as of June 4, 2021.

The nation's largest banks, institutions with assets greater than $250 billion, have lowered rates on one-year CDs the most since June 5, 2020, dropping rates by 26 basis points. Those banks have recorded by far the greatest deposit growth in recent quarters and have seen their loan-to-deposit ratios plummet.

With the recent decreases, CD rates are below levels not seen since 2015, when short-term rates had been pegged near the zero bound for close to seven years. CD balances have declined even more and stand well below the lows recorded in 2017 after years of persistently low rates.