Are Retail Deposits Really Better?

Breaking down the "stickiness" of retail depositors

None of this is financial advice.

It is a long-held belief among bank investors and observers that the elusive retail depositor is the best customer a bank can have in a rising-rate environment. The running theory is that they are far less likely to move their money out of the bank’s (presumably low-interest) checking or savings account to another bank just for the rate pickup.

While there are many interesting data points about how the rise of online banks somewhat changes this dynamic - for example I myself have my checking account at BofA and a Goldman Marcus Savings account for excess cash - for the most part, these challengers are still dwarfed by the big 4 consumer banks (Chase [JP Morgan], Wells Fargo, Bank of America, and Citi [kinda]). The talking point can basically be summed up in the following three exhibits using Bank of America as an example.

Case Study

Bank of America is quantifiably enormous and has multiple different business lines incorporating corporate banking, wealth management (Merrill Lynch), investment banking, and obviously consumer banking. The consumer bank is what is probably best known to main street America because they have branches everywhere. So this first exhibit is just showing that at $2trn in deposits they even dwarf most of the top 10 largest banks in America (by deposit size). The gap between them and Wells Fargo is more than all the deposits at PNC (America’s 6th largest bank by deposits)

Within BofA, the consumer bank is just over half of all deposits, meaning their consumer bank alone would be the 4th largest bank in the United States. More than half of the deposits at the consumer bank are held in checking accounts (including both non-interest bearing and interest bearing accounts).

You might be asking, what rate are they paying on those $1trn of consumer deposits, well a quick search yielded this fun little table. This is the standard pricing for their savings product (pretty sure all IB checking accounts are just 1 basis point APY). Lo and behold the honor of being a Platinum or Diamond member with your measly 4bps.

So, the culmination of all this results in a 2 basis point cost of deposits on 1.1trn of deposits. Also note, that these depositors do very little lending business with BofA as shown by the sub 30% loan-to-deposit margin. Meaning that BofA can use this funding to invest in higher-margin businesses (or just deposit it at the fed and earn 4.3% risk-free).

So, through this lens, it’s easy to say that retail accounts are far better. However, it’s key to remember that this type of operating leverage has only come through enormous scale and tremendous investments in technology. There are probably only 4 or 5 banks in the world that have the digital capabilities, operational scale, and product breadth that Bank of America has, so yes for those banks the retail account is the crown jewel of the banking world.

Getting to the point…

But what about the other 4,000 banks in America? What do their retail accounts like? This is where my thought piece began.

I should start by noting that retail/consumer deposits are not a GAAP reportable item, nor are they included in call reports, however, there is a line item on call reports that references the total dollar amount of deposits held at a bank in accounts under $250k. So for the purposes of this analysis, I will be referencing deposit accounts included in this category as retail deposits, and anything not included under this designation as commercial accounts.

Obviously, this is a generalization, considering there are many consumers who may have more than $250k in their account or businesses with multiple operating accounts that are under that threshold. However, I would argue that any individual carrying that type of balance at a bank is more of a rate shopper than a lower-balance consumer. On the flip side, businesses with operating accounts below that amount are less likely to be rate shoppers given they are as usually not as sophisticated as a larger depositor. One caveat I will call out is that I chose not to include any retirement accounts (over or under $250k) in this retail account designation, despite the fact they are by definition retail accounts. The reason for this is that the whole point of this analysis is to isolate the non-rate shopping accounts that retail depositors usually carry and a retirement account is more likely to be looking for a higher yield than a standard checking account.

Therefore, without any more caveats, the next item to cover is the distribution of these types of accounts across the banking sector as not only is it not normal distribution, it has evolved in an interesting manner over the past 7 years.

I chose to start this analysis in 1Q15 as that was a point in time when ZIRP (Zero Interest Rate Policy) was still firmly intact. At that point, there were over 6000 regulated depositories (banks) in the U.S. versus just over 4500 today. Interestingly, as shown in the chart below, there was more of a retail skew to the average bank at that time. The median bank had 32% of their deposits in “commercial” accounts versus 43% today.

For simplicity of analysis, “retail” banks are on the left and “commercial” banks are on the right.

My initial hypothesis was that a decent amount of this could be explained by M&A from commercial banks buying retail deposit bases, after all, there has been a 26% drop in bank charters since 1Q15. However, after analyzing the banks that are still in operation today and looking at their retail account percentage in 1Q15 I found that the % of commercial accounts was remarkably similar to the median bank at that time, coming in at 32%. Therefore the M&A theory for small retail banks being adversely selected as take-out candidates proved to be incorrect.

My second hypothesis was that the largest banks took market share in the smaller retail accounts given their tech investment discussed above. However, while the deposit market share of the top 10 “retail banks” did increase from 43% to 47%, it was less than I had anticipated and less than enough to explain the move 11% move in the median bank commercial deposit percentage.

If you’re thinking this number might be inflated due to some of the largest banks like Suntrust/BB&T and PNC/BBVA M&A influencing this top 10 list, don’t worry I had a similar thought. However, the delta between 1Q15 and today remains at 4% even excluding those two deals.

So, what could’ve caused this shift from more banks moving up their commercial deposit concentration? Well honestly, the results are a bit unclear, but it seems to be a case of the rich getting richer in some ways. By this, I mean that overall US deposit growth between 1Q15 and 3Q22 was 61% while the deposit growth of accounts less than $250k was only 50%.

To me, this chart says illustrates how commercial customers and higher net worth depositors have grown their accounts at a much faster pace than traditional retail accounts over the past 7 years.

Side note: it is pretty remarkable the traction that Chase has built on the consumer deposit side in the past 7 years.

Why does this all matter?

The reason I went through the trouble of dissecting any bank’s exposure to retail accounts all comes down to whether the true retail banks are able to leverage those price-insensitive customers during a rising rate environment. To do this, I joined the analysis I did above with those banks’ cost of IB deposits (also derived via call reports).

What I discovered was that while retail banks were able to lag commercial banks on repricing accounts during rising rate environments, they also start at higher costs than their commercial peers. Also, the lag effect works both ways and during interest rate-cutting cycles commercial banks reprice downward almost immediately while retail banks take much longer. The conclusion? The best banks have both commercial and retail deposit customers, with a skew of 35% commercial and 65% retail resulting in the lowest cost of interest-bearing deposits through the cycle. Now, if you are a bank investor or observer, none of this is truly revolutionary news, but I still think you will still be interested to see how the charts illustrate this narrative.

One caveat that is rather important to note is that this analysis is only on interest bearing deposit costs and excludes all non-interest bearing accounts. This is notable considering that commercial banks traditionally have much higher non-interest bearing concentration than retail banks. While I would love to include this information in my analysis, for some reason, call reports do not require average non-interest bearing deposits on the RC-K schedule. This has been tremendously aggravating for numerous reasons as I have found multiple discrepancies when averaging the regulatory reported non-IB accounts on the RC-Balance Sheet schedule. So, while I thought about doing that, I decided to stick with what was explicitly given and footnote this in my analysis.

This analysis will be broken down by interest rate policy into 5 segments: 1Q15-3Q15 ZIRP, 4Q15-2Q19 Hiking Cycle, 3Q19-2Q20 Cutting Cycle, 3Q20-4Q21 Pandemic ZIRP, and 1Q23-Present Hiking Cycle. In the charts you will notice I include a bolded black line for the first quarter of the following segment, this is because lagged pricing and IR changes late quarter usually result in a one quarter lag in IB deposit costs to any policy changes that occur.

Zero Interest Rate Policy (1Q15-3Q15)

This first segment is really to set the stage, ZIRP had been in place for many years now so 1Q15 was not a unique period to start by any means but rather it was just to give a glimpse at what the interest rate environment looked like for most of the early half of the 2010s on the deposit side. The main thing to note here is that you can see commercial banks have an overall lower cost of IB deposits in this environment than retail banking peers.

Fed Hiking Cycle (4Q15-2Q19)

As you may remember, the rate of hiking was slow at first with only one hike in December 2015 and another one in December 2016 but picked up steam from there hitting a peak range of 2.25%-2.50% in December 2018 and lasting there until July 2019.

Here is our first glimpse of just how quickly commercial deposits reprice and as we can see they were very strong out of the gate and by 2Q17 had picked up the entire rate delta to retail banks that they had forgone during ZIRP.

As shown below, the variance for heavier commercial banks is a much wider band than those for retail banks during this hiking cycle. However, after about a year of holding the line on costs, more or less, we can see that the retail banks started to ramp up their rate offerings by mid-2018 and would stair step up from there every quarter. This tells me that while the lag is very present in the early part of rate-rising cycles, the damn does eventually break for those retail accounts at which point they start to reprice much faster.

An interesting observation here, and shown more in the next segment, is the delta between full commercial banks between 1Q19-2Q19 IB deposit costs is lower than that for retail banks over the same period. This means that the commercial banks had more or less stabilized their rate increases by 1Q19 while retail accounts were still moving up substantially each quarter.

All in all, full retail banks had about a 26% beta to fed funds (from 0.64% in 1Q15 to 1.22% in 3Q19) while full commercial banks had about 52% beta (from 0.35% in 1Q15 to 1.51% in 3Q19) on their IB accounts. The cohort with the lowest overall IB deposit costs and low beta was those banks with 30-40% of accounts with commercial depositors, they had a 26% beta overall and had peak IB deposit costs of around 1.10%

Rate Cutting Cycle (3Q19-2Q20)

As the Fed began to cut in late 2019 and accelerate the pace during the early days of the pandemic commercial banks were able to cut deposit pricing much quicker than retail banks. The lag effect is substantial here are retail accounts experience very limited downward beta while commercial accounts repriced almost immediately. Not a ton to add here outside of the obvious fact that what goes around comes around and consumers may be slow to reprice deposits on the way up, but they are just as slow to digest the cuts on the way down.

Pandemic ZIRP (3Q20-4Q21)

Following the rate cuts, the Fed remained firmly in the dovish territory while pandemic stimulus and PPP ratcheted up inflation. They remained firmly in ZIRP camp until late 2021.

I think this is the only chart I have in this analysis where the swings on the consumer bank side are more aggressive than those on the commercial side. Although, as you can see the final two quarters of the Pandemic ZIRP look a lot like the 1Q15 ZIRP shown above. Retail accounts eventually repriced downward to where they were before the hiking cycle began, it just took them over two years to do so, while commercial banks were much quicker on either side of the Fed moves.

One interesting item to take note of is that if you compare the 4Q21/1Q22 trend line to 1Q15/2Q15 there is a difference in that in 2015 the more commercial accounts you had the lower your cost of IB deposits during ZIRP meaning 100% commercial banks had the lowest overall IB deposit costs, but this time the line forms a trough somewhere around 70% commercially oriented banks.

Inflation-Driven Hiking Cycle (1Q22-Present)

Finally, we arrive at the present. Today the Fed Funds rate sits between 4.25% and 4.50% or a full 2% points above the prior hiking cycle and it took 1/4 of the time to get here. Currently, the forward curve has something like 1 hike in early 2023 and 1.5 cuts in late 2023.

I think we all kind of expected this one, but it’s still staggering to see the rate delta on the commercial accounts. As anyone that dared to read this far probably already knows, the Fed has entered a massive hiking cycle to offset sticky inflation. Retail banks have held the line somewhat while commercial banks are getting steamrolled by clients who are probably threatening to move their excess cash into treasuries. The most surprising to me has been the ability of that 30-45% cohort to hold the line on deposit costs.

Obviously, it is too early to say where things will shake out as betas are still much lower than they will end up shaking out. Even for commercial banks, thru 9/30 they had only moved deposit costs from 31bps in 1Q22 to 1.12% in 3Q22, which is about a 27% cycle to date beta.

Going forward, many observers are expecting NIMs to peak in 1Q23 or 2Q23 with deposit betas picking up through this year. I will keep my thoughts to myself but will say that the Fed officials seem steadfast in their belief that rates need to stay “above terminal rate” for a good amount of time to trickle through the system. While that is bad for deposit costs, one benefit of this hiking cycle to the banks has been to clear the deck for wholesale-funded lenders. By this, I mean that non-bank lending has grown significantly since the 08 crisis, and much of this was fueled by cheap wholesale funding to these lenders. Now, banks across the spectrum should be able to flex their lower- cost funding in deposits to crowd out some of these lenders while still earning a profitable spread.

Conclusions

Anyway, this whole thought exercise was something I had been wanting to run through for a while and while there weren’t any major surprises I think laying the data out there helps to look at banks through a new lens. Basically, it shows that for banks to be best positioned for any rate environment they need some mix of commercial and retail accounts to keep a balanced ship with the best banks having a slight retail skew to their deposit base. Thanks for making it this far, for your troubles you can find a haphazardly made gif of the above charts that took me way longer to make than is worth.