A shift from banks into wholesale borrowing flattened out in the second quarter as the industry paid down emergency funding from the Federal Home Loan Banks (FHLB).

Wholesale borrowing as a percentage of total funding increased by a modest 34 basis points from the first quarter to 15.46% in the second quarter across the industry, according to data from S&P Global Market Intelligence. The share of wholesale borrowing had been increasing by more than a percentage point quarterly since the middle of 2022, as a flood of cheap deposits receded, and it spiked by 3.09 percentage points in the first quarter this year, when banks bolstered cash levels to meet potentially severe deposit outflows after the failures in March.

For most banks, severe deposit outflows did not materialize, and the industrywide deposit decline moderated in the second quarter as banks lifted the rates they pay. Banks remain under pressure from rising funding costs, but the relative calm has allowed the industry to trim cash levels.

"Into [the third quarter], banks have started to right-size elevated levels of cash and pay down wholesale borrowings on the balance sheet as both industry and macro uncertainty subside," analysts at Jefferies said in a Sept. 5 note, adding that "banks are still vulnerable to rising deposit costs" because of flows out of non-interest-bearing deposits and increases in higher-cost time and brokered deposits.

Still lower than pre-pandemic

FHLB advances fell by a median 8.7% sequentially in the second quarter across the 20 biggest FHLB borrowers.

Aggregate FHLB borrowing as a proportion of total liabilities was up substantially at 3.11% during the period from a recent low of 0.88% in the fourth quarter of 2021, though it was comparable to pre-pandemic levels, with the quarterly proportion ranging from 2.92% to 3.76% in 2018 and 2019.

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At 15.46% in the second quarter, the ratio of all wholesale borrowing to total liabilities was also substantially higher than a recent low of 8.44% in the fourth quarter of 2021, but remained below a quarterly range of 16.65% to 17.82% in 2018 and 2019. Despite the growth in the ratio for brokered deposits to 5.68% in the second quarter, it also remained below the range of 6.27% to 6.80% in 2018 and 2019.

Abrupt shifts

While aggregate wholesale funding has not pierced 2018 and 2019 levels, the exit from the pandemic environment has resulted in abrupt changes in funding profiles.

Among the 10 banks with the biggest year-over-year increases in ratios of brokered deposits to total liabilities, the increases ranged from 27.0 percentage points to 85.9 percentage points at Silvergate Bank, which is liquidating itself after the crypto meltdown.

The list also includes PacWest Bancorp, which did experience large deposit outflows in the spring and raced to shed assets in response.

PacWest struck a deal to merge with Banc of California Inc. in July, and the two banks plan to jettison more loans and securities as they seek to cut their combined wholesale funding by $13 billion, including about $6 billion of brokered deposits.