Migration into high-cost time deposits moderated in the second quarter as US banks continued to raise the rates they pay across a variety of account types to hold onto core funding.

Time deposits, which fell during the pandemic, started to increase again in early 2022 when the Federal Reserve began raising interest rates. The pace of that migration peaked in the first quarter of 2023 when time deposits as a portion of total deposits increased 2.7 percentage points sequentially to 12.3%, but the shift eased in the second quarter with the ratio increasing 1.9 percentage points sequentially to 14.2%, according to data from S&P Global Market Intelligence.

The data shows that banks remain under pressure from rising funding costs, but a number of banks say there is at least a bend in the curve and that net interest margin (NIM) bottoms are coming into view. Bank of America Corp. said movement by wealth management customers into higher-yielding alternatives appeared to stabilize in the second quarter. Citizens Financial Group Inc. said it expects its ratio of non-interest-bearing to total deposits to hold roughly steady after returning to a pre-pandemic level of about 23% in the second quarter.

"Deposits have stabilized and the so-called 'walk' on deposit flows in March and April 2023 was temporary and now banks are paying substantially higher interest rates for new funding," Janney Montgomery Scott analyst Christopher Marinac said in a note on Aug. 21, referring to abrupt money movements amid the bank failures this year. "Customers will do what they are paid to do — banks paying more interest are able to retain more deposits."

Easing outflows

Total deposits declined by $106.05 billion, or 0.6%, sequentially in the second quarter to $17.198 trillion, a smaller amount than the drop of $421.65 billion, or 2.4% in the first quarter.

At BofA, period-end deposits fell 1.7% sequentially to $1.877 trillion, which CFO Alastair Borthwick, in a second-quarter earnings call, described as "a good result" in view of seasonal pressures like tax payments, along with the Federal Reserve's ongoing policy of reducing its asset holdings and withdrawing liquidity from the economy.

Conversely, Citizens Financial's deposits increased 3.2% sequentially to $172.19 billion as its cost of deposits increased 40 basis points to 1.68%. With the deposit growth and after earmarking $14 billion of consumer loans for sale, Chairman and CEO Bruce Van Saun said on the company's second-quarter earnings call that the bank no longer needs to "aggressively grow deposits" as it makes progress in lowering its ratio of loans to deposits.

Huntington Bancshares Inc.'s deposits increased 1.9% quarter over quarter to $148.03 billion as its NIM compressed by 29 basis points to 3.11%. "It's a competitive environment," CFO Zachary Wasserman said in a second-quarter earnings call. But "the deposits are there."

Like other banks, Huntington is curtailing lending and Wasserman said the deceleration in loan growth across the industry is providing an "escape valve" for funding pressures.

While overall deposit outflows slowed in the second quarter, banks do not appear to expect a return to growth soon. Fewer than half of respondents in S&P Global Market Intelligence's 2023 US Bank Outlook Survey anticipate deposit growth at their institutions over the next 12 months.

Paying up

Meanwhile, deposit rates continue to march higher.

Banks' cost of funds increased 42 basis points sequentially to 1.98% in the second quarter, according to S&P Global Market Intelligence data.

That is smaller than the increase of 47 basis points in the first quarter and 49 basis points in the fourth quarter of 2022, but the Fed has been slowing its rate increases as it appears to approach an endpoint.

That means that sequential betas, or the increase in banks' cost of funds relative to the increase in underlying overnight rates in a given period, have ratcheted up as deposit costs gravitate toward short-term rates that have now pierced 5%.

The sequential beta was 33.6% in the fourth quarter of 2022, 54.0% in the first quarter of 2023 and 89.7% in the second quarter. As of the second quarter, the cumulative beta, or the change in deposit costs relative to underlying rates since the fourth quarter of 2021, before the Fed started raising rates, was 37.4%, higher than the last tightening cycle, when the increase in underlying rates was shallower.

Truist Financial Corp. said it now sees its cumulative beta for just its interest-bearing deposits going above 50% this cycle, CFO Michael Maguire said during a second-quarter earnings call, though he declined to "pick a number" precisely because of uncertainty about the ultimate path of interest rates.