Banks using high-yield CDs to boost balance sheets

The squeeze is on at financial institutions. In need of liquidity, they are offering products such as certificates of deposit at abnormally high yields to lure new depositors.
Last month, Sovereign Bank led the way locally by offering a one-year CD with a 4.25 percent annual percentage yield, far above the national average.
The move was a bid to recapture billions of dollars in deposits withdrawn by customers from the Philadelphia-based bank while it racked up millions in losses during unprecedented turmoil in the financial markets.
Public filings of the bank’s parent company, Sovereign Bancorp, indicate that total deposits declined $6.79 billion – or 13.61 percent – in the first nine months of 2008, from $49.92 billion to $43.12 billion.
But the high-yield CD offering also comes at a time when the federal funds rate – and in turn, the prime-rate benchmark used to set loan interest rates – has been reduced. Keeping CD rates at the same level, and in some cases increasing them, to attract depositors squeezes a financial institution’s interest margin and lowers profits.
While other local institutions didn’t exactly move to match Sovereign’s special rate – which ended in late November – many in Rhode Island have not dropped their rates to match the fall of the federal fund rates.
Before the financial crisis, banks “were undercutting each other on the loan side to pick up customers – basically reducing the spread” between the cost of borrowing and lending, said Peter Nigro, professor of finance at Bryant University.
Now it’s happening on the deposit side, he said.
Because of the credit crunch, banks and credit unions are finding that offering high-yield CDs is a less expensive way to get cash for lending and to shore up a balance sheet.
“Even at 4 percent, it’s cheaper than raising capital elsewhere,” Nigro said. “It is the cheapest source of funds.”
For Sovereign, the high-yield CD promotion – while likely sapping its interest income – boosted the bank’s deposits. Sovereign said in a statement to Providence Business News that total deposits are up 7 percent so far in the fourth quarter, a turnaround the bank attributed to the CD rates and the decision by the Federal Deposit Insurance Corporation to increase the amount of insurance coverage on deposits.
Yields have been on the decline of late, with the national average yield on a one-year CD dropping to 3.22 percent on Dec. 10, from 3.30 percent a week earlier, according to Bankrate.com. In a check of some local banks’ rates, it appears that most banks in the Rhode Island market are below that average.
That’s not to say financial institutions here are not offering competitive rates.
“Deposits are essentially the raw material of the banking business – that’s what allows you to go out and make loans,” said B. Michael Rauh Jr., The Washington Trust Co.’s executive vice president of sales, service and delivery. “Having deposits and getting deposits is always of the utmost importance.”
That said, Washington Trust executives haven’t felt compelled to boost CD rates exorbitantly. Last week, the bank’s standard one-year CD rate was 2.72 percent.
“Because of all the turmoil surrounding large institutions around the country, I think there has been a flight to smaller community institutions where you know the customer and the customer knows you,” Rauh said. “We’ve had a very positive in-flow of deposits and we have not had to price at the top of the market for that.”
Also helping Washington Trust’s liquidity situation: The bank raised about $47 million in October through a private sale of stock.
It’s a different situation for community institutions such as BankNewport, a mutual savings bank that cannot issue shares to raise capital, making deposits even more critical for its lending operations.
The bank keeps close tabs on the competition, calling or checking Web sites weekly to find out what other banks are offering, according to Susan Replogle, senior vice president of branch administration.
In fact, BankNewport added a five-month CD product in October that features up to a 3.75 annual percentage yield for qualified depositors after the bank’s research showed a need.
“We didn’t have a short-term CD and a lot of the competitors did,” Replogle said. “We felt that was what the customer was looking for, so we added it.”
Executives at Bank Rhode Island – which has applied for the U.S. Treasury’s Capital Purchase Program and is qualified to receive up to $30 million – say they are in the midst of developing an “aggressive” market plan for 2009 that will work to “retain and build deposits,” according to Stephen R. Hourahan, a spokesman for BankRI. He declined to give specifics.
Nigro said he expects that the competition will only intensify as entities such as investment banks Goldman Sachs and Morgan Stanley are converting to bank holding companies that will seek to get access to funding through deposits.
And he added that technology and the existence of online banks have made it easier for consumers to branch out beyond their own geographic areas when shopping around for the best yields.
“Technology has really transformed and intensified the competition for bank deposits,” Nigro said. “The definition of a banking market has changed as deposits are no longer local; they’re national. And this makes the deposit base a lot less stable than it use to be for commercial banks.”
Replogle said BankNewport is attempting to counteract the lack of “stickiness” to CDs by trying to develop a relationship with those depositors. “We don’t just want to have the product of the month or the highest rate,” she said. “If someone only has a certificate with you and you don’t have their other banking, they do just tend to bounce around.”
When the financial crisis gained momentum, Replogle said, customers were more concerned about the health of a financial institution in finding a place to park their money. Now that the FDIC has raised its insurance limits from $100,000 to $250,000, customers are again making decisions based on rates.
“It is tough when you get into something like this when rates are going down for the mortgages but the competition isn’t really changing rates on the deposit side,” she said. “You’re stuck with a real squeeze. That’s one of our biggest challenges.” •