KBRA Financial Intelligence

Fed Rate Cuts to Transform Growth of U.S. Money Supply, Heighten Pressure on Banks With Heavy Time Deposit Exposure

Welcome to the KFI Monthly Insights. In this edition, we highlight the following key topics:

• The Fed’s policy shift and its impact on bank deposit compositions, as well as the M1 and M2 monetary aggregates

• How a surge in time deposits could create a funding overhang, squeezing some banks’ lending margins as rate cuts drag on long-term yields

• Mergers and acquisitions (M&A) activity among U.S. lenders continues to show signs of rebound after the slowest year in recent history

The Federal Open Market Committee (FOMC) initiated monetary easing in the U.S. on September 18 with a 50-basis point (bp) rate cut. This policy shift will not only impact the Federal Reserve’s benchmark overnight rate, but also the overall U.S. money supply. Similar to how bond traders had long factored an expected easing cycle into long-term interest rates, the expansion of U.S. monetary aggregates began well in advance of the central bank’s formal actions.

The M1 gauge of the money supply includes currency outside of the U.S. Treasury, Federal Reserve Banks, and depository institution vaults, as well as demand deposits and other liquid deposits. Though M1 was still contracting at an annual rate of about 0.46% in August, broader measures like M2 have shown year-over-year (YoY) growth for several months. M2 encompasses the M1 money stock, along with small-denomination time deposits (less than $100,000) and retail money market funds.

Following an unprecedented surge in U.S. money supply in the wake of the COVID-19 pandemic, both aggregates experienced their largest historical contractions during 2022-23. This was driven by rate hikes and a multi-trillion-dollar reduction of the Fed’s balance sheet, which withdrew vast sums of liquidity from the economy. So far, M2 has rebounded more sharply than M1, largely because persistently high interest rates have attracted substantial capital to interest-bearing accounts. Money market fund investments reached a record $6.55 trillion in 2Q 2024, while the total of large- and small-denomination time deposits at U.S. commercial banks remains just below the record $3.46 trillion set earlier this year. With the Fed halving its balance sheet reduction since June and monetary policymakers forecasting another 50-bp rate cut by year-end, the renewed expansion of monetary aggregates is expected to continue accelerating.

However, the Fed’s ongoing dovish shift will likely alter the course of U.S. monetary growth. Historically, lower rates tend to boost demand for liquidity over yield, slowing or reversing the accumulation of time deposits and other checkable deposits, which typically pay no interest or offer variable rates that can be adjusted downward.

As KFI previously noted, the easing of inflation will likely offer some relief to banks that have been burdened by surging deposit costs. In our sample, the average cost of interest-bearing deposits—calculated as the interest expense from deposits relative to interest-bearing deposits—was 2.6% in 2Q 2024, up 89 bps from the same period in the year prior. This has made the process of keeping banking products competitive in terms of yield, while protecting profit margins, which is a difficult prospect for depositories. FDIC data released last month showed that deposit cost growth among U.S. banks had risen at a faster pace than loan yields across five of the six quarters to 2Q 2024. One common type of interest-bearing deposit is the time (or term) deposit.

While many banks will benefit broadly from easing rates ushering in stronger demand deposit growth, some institutions that have built up large concentrations of time deposits may continue to struggle with elevated funding pressure. Fed cuts tend to push down long-term yields, influencing the rates banks can apply to new lending, but time deposits are typically locked in at a certain rate for a duration of years. For example, if a time deposit does not mature for three years, the bank must balance the interest it pays on this liability with the yield from assets over that period.

In 2Q 2024, 18.14% of time deposits at U.S. banks had maturity dates extending more than a year. Many of these deposits, accrued within the past year, are likely tied to particularly high fixed rates. The yield on U.S. 10-Year Treasury bonds, a key lending benchmark for many different types of debt, has already fallen by more than 120 bps from a 2023 peak of almost 5.0%, and further rate cuts by the Fed could further suppress long-term yields. For some banks heavily exposed to steep funding rates, one concerning method they could deploy to protect their net interest margins (NIM) from compression would be to add riskier bets to their loan book, which carry a greater yield to compensate for the poorer quality of borrowers.

Several banks with above average holdings of time deposits carrying maturities greater than one year have undertaken a sizable buildup of time deposits within the past four quarters to 2Q 2024, when the fed funds rate was sustained at a two-decade high and funding costs began surging across the U.S. banking landscape. Utah-headquartered Nelnet Bank (KFI Score: B-) had just $1.03 billion in deposits in 2Q, but the heaviest concentration of time deposits with a maturity date more than a year away. Despite an 18.66% increase in Nelnet’s total time deposits YoY, this type of deposit constitutes just over one-quarter of their total deposits, well below the average 30.92% among a cohort of banks with less than $50 billion in total deposits.

The larger BNY Mellon, National Association (KFI Score: B) has a higher ratio of time deposits to total deposits at 41.52%, exceeding the cohort average. The bank has also seen a materially larger buildup of time deposits over the past year at 25.15%. Texas Exchange Bank (KFI Score: B), First National Bank of America (KFI Score: B), and Celtic Bank Corp. (KFI Score: B) stick out as institutions with especially high exposure to time deposits that may be locked into heightened rates for multiple years to come. At least 88.21% of each of those banks’ total deposits comprise time deposits, and 73.35% or more are tied to maturities that are more than 12 months away. Notably, Texas Exchange Bank’s cost of time deposits is significantly lower than the cohort average of 3.93%.

Though the average cost of time deposits for the cohort of banks with more than $50 billion in deposits is steeper at 4.67%, the concentration of time deposits to total deposits is generally lower among these larger institutions, calculated as 16.58%. The time deposit concentrations of UBS Bank USA (KFI Score: A-), Morgan Stanley Bank, National Association (KFI Score: B+), Discover Bank (KFI Score: C+), Synchrony Bank (KFI Score: C-), and BMO Bank, National Association (KFI Score: B) each exceed that average. Of that grouping, Synchrony has the most elevated ratio of time deposits to total deposits at 56.53%, as well as the largest YoY increase in their cost of time deposits. Morgan Stanley’s cost of deposits is an above average 5.05%, and BMO Bank saw its time deposits increase by nearly one-third YoY in 2Q 2024.

Recent M&A

REV Federal Credit Union (KFI Score: B), a $1.1 billion lender in Summerville, South Carolina, announced an agreement to acquire First Neighborhood Bank (KFI Score: B), a $150 million lender in Spencer, West Virginia, for an undisclosed price, according to a September 3 press release. The deal is expected to close in 2Q 2025.

Builtwell Bank (KFI Score: B), a $1.8 billion lender in Chattanooga, Tennessee, announced an agreement to acquire $351 million Bank of Cleveland (KFI Score: A-) for an undisclosed price, according to a September 5 press release. The deal is expected to close in 1Q 2025.

NBT Bancorp Inc. (NASDAQ: NBTB) (KFI Score: B+), a $13.5 billion lender in Norwich, New York, announced an agreement to acquire Evans Bancorp Inc. (NYSE: EVBN) and its $2.2 billion bank subsidiary, Evans Bank, National Association (KFI Score: B-) in a deal valued at $236 million, according to a September 9 press release. The deal is expected to close in 1H 2025.

Camden National Corporation (NASDAQ: CAC) (KFI Score: B), a $5.7 billion lender in Camden, Maine, announced an agreement to acquire Northway Financial, Inc. (OTCQB: NWYF), the parent company of Northway Bank (KFI Score: B), a $1.2 billion lender in Berlin, New Hampshire, in an all-stock transaction valued at $86.6 million, according to a September 10 press release. The deal is expected to close in 1Q 2025.

Sandia Laboratory Federal Credit Union (KFI Score: B-), a $4.1 billion lender in Albuquerque announced an agreement to only acquire the New Mexico-based business from Mountain America Federal Credit Union (KFI Score: B+), a $19.6 billion lender in West Jordan, Utah, for an undisclosed price, according to a September 12 press release.

EverBank Financial Corp. (KFI Score: B), a $39.4 billion lender in Jacksonville, Florida announced an agreement to acquire Sterling Bancorp (KFI Score: A+), a $2.4 billion lender in Southfield, Michigan, in an all-stock deal valued at $261 million, according to a September 16 press release. The deal is expected to close in 1Q 2025.

Liberty Capital Bancshares, the parent company of $414 million Liberty Capital Bank (KFI Score: B+) to acquire $225 million Texas Heritage Bank (KFI Score: B), the banking subsidiary of Southwestern Bancorp, Inc., for an undisclosed price, according to a September 19 press release. The deal is expected to close in 4Q 2024.

ESL Federal Credit Union (KFI Score: B), a $9.3 billion lender in Rochester, New York, announced an agreement to acquire $400 million Generations Bank (KFI Score: B-) and its parent company Generations Bancorp NY, Inc. (NASDAQ: GBNY) in an all-cash transaction for $26.2 million, according to a September 24 press release. The deal is expected to close in 2Q or 3Q 2025.

TowneBank (NASDAQ: TOWN) (KFI Score: B+), a $17.1 billion lender in Portsmouth, Virginia, announced an agreement to acquire $745 million Village Bank (KFI Score: B), the bank subsidiary of Village Bank and Trust Financial Corp. (NASDAQCM: VBFC), in an all-cash transaction for $120 million or $80.25 per share, according to a September 24 press release. The deal is expected to close in 1H 2025.

Mifflinburg Bancorp, Inc. (OTCPK: MIFF), the parent company of $565 million Mifflinburg Bank and Trust Company (KFI Score: B) announced a merger agreement with Northumberland Bancorp (OTCPK: NUBC), the parent company of $685 million The Northumberland National Bank (KFI Score: B), in an all-stock transaction with a total deal value of $34.2 million, according to a September 25 press release. The deal is expected to close in 1H 2025.

Self Reliance NY Federal Credit Union (KFI Score: B-), a $1.4 billion lender in New York, announced a merger agreement with Ukrainian Selfreliance Federal Credit Union (KFI Score: B-), a $535 million lender in Chicago, for an undisclosed price, according to a September 27 press release. The deal is expected to close in 2025.

Digital Federal Credit Union (KFI Score: B), an $11.9 billion lender in Marlborough, Massachusetts, announced a merger with First Technology Federal Credit Union (KFI Score: B-), a $16.7 billion lender in San Jose, California, for an undisclosed price, according to a September 30 press release. The deal is expected to close in 2025.

Byline Bancorp (NYSE: BY) (KFI Score: B), a $9.6 billion lender in Chicago, announced an agreement to acquire First Security Bancorp, Inc., the parent company of First Security Trust and Savings Bank (KFI Score: B+), a $354 million lender in Elmwood Park, Illinois, in a cash and stock transaction valued at $41 million, according to a September 30 press release. The deal is expected close in 2Q 2025.

In Case You Missed It

Follow KFI’s blog for our latest research, data analytics, and product updates. Read our insight pieces on 10,000 banks, credit unions, and more. Some of our recent analysis highlights include the following:

• Despite a notable drop in mortgage rates, purchase volume in the residential market remains sluggish, reflecting ongoing affordability challenges and economic uncertainty.

• While residential mortgage loans and overall home sales continue to lag significantly behind the highs of 2020-21, new home sales have shown a notable recovery, all while home construction data indicates a strong rebound, with single-family starts experiencing a substantial month-over-month increase.

• The latest Summary of Deposits (SOD) data from the FDIC reveals differences in bank market share composition, highlighting that Texas’ deposits are predominately concentrated within the commercial and savings banks of the largest U.S. bank holding companies, whereas Massachusetts exhibits a greater reliance on regional institutions.

Van Hesser’s 3 Things in Credit

September 6: Savings Rate, 2025 Earnings, and Beige Book

September 13: Bank Warnings, Small Business Struggles, and Post-Inflation Risks

September 20: Fed’s Big Move, Credit Exuberance, and Post-Cut Expectations