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Amid rapid deposit growth, particularly during the first two years of the pandemic, banks of a variety of sizes chose to invest some of that cash in bonds, a move that would end up leading to Silicon Valley Bank’s decline.
Some banks, including community banks, have started to see pressures on their cash liquidity coming out of 2022 when deposit growth leveled off even as banks saw strong loan growth, said Jeffrey Reynolds, a managing director at Newburyport-based Darling Consulting Group.
Tactics used by banks to address pressures have included reducing cash liquidity, borrowing from the Federal Home Loan Bank and bringing on brokered deposits, Reynolds said. He added that while community banks would typically not be concerned at this point about liquidity, the size of their bond portfolios has brought on some complications.
“Their loan-to-deposit ratios are below historical norms,” Reynolds said. “The issue is that a lot of the liquidity that banks have is locked into bonds that are at depressed values.”
Options for banks to increase liquidity tied to their bond portfolios include using cash flow from the portfolio, selling bonds at a loss or using the bonds as collateral to borrow funds.
While banks might end up second-guessing whether they should have invested in bonds in 2020 and 2021, Reynolds said, even in 2021, questions still remained around the effects the pandemic would have on the economy.
Community banks will face other pressures on their finances. Strong loan growth meant community banks came off a year where they were able to earn more profits off their interest margins, Reynolds said. Now that banks have started to pay higher interest rates on some of their deposit products, Reynolds expects margins to tighten again. While loan growth has continued into the first quarter, he has seen signs that loan pipelines might soften.
A switch to a new accounting method could also affect bank finances. Community banks, if they did not do so in recent years, are switching this quarter to the current expected credit losses methodology, which could increase the amount of provisions set aside for loan losses.
While banks have become concerned about the potential for troubled loans, Reynolds has not seen any increases yet in problem loans.
“If I see upticks at community banks for credit provisions, I think it’s going to be more related to [CECL] than it is credit deterioration,” Reynolds said.
