2024 The Year of the Brokered Deposit

Rebecca Bacon, VP, Head of Financial Institutions at Upgrade

As financial institutions are shoring up balance sheets after the mini-banking crisis of March 2023, the 2024 liquidity situation appears to have stabilized. Although regulatory reserve requirements like Basel III mixed with CECL are not making it easier on the bank or credit union CFO these days. In light of deposit outflows, market panic post-March, and new regulations, this trio of events is compounding banks' and credit unions' desire to retain capital. This is counterintuitive to their money-making business model, lending capital. Similar to a consumer panicking during a recession, pulling back on spending and then making matters worse for the macroeconomic environment, as banks grow too cautious on capital, the income side of the equation will also start to dip, exacerbating the problem.

In my role at Upgrade (Upgrade is an online marketplace for loans/deposits that are ultimately sold/swept to banks and credit unions), I have the privilege of engaging with CFOs at a wide variety of institutions. This mix includes large money center banks with assets topping $900B and small community credit unions with assets of $90M. The focus and approach, regardless of size and sophistication, have a lot of the same philosophies. What I have found most interesting is the paralysis and the waiting out whatever this is we have been in for the past 18 months. Similar to all investment opportunities, whether consumer or institutional accredited, it is very much an opportunistic market. As liquidity gets tight, interest rates rise, and the net interest margin bar gets higher and higher. So instead of focusing on growing income to bring in more capital that could potentially be used to lend in generating more income, I have seen FIs remain on the sidelines and forgo income-earning opportunities, waiting for "liquidity to stabilize." the approach should be considered instead of conservative even riskier.

The rise of the brokered deposit has been successfully deployed across financial institutions. The origin of the brokered deposit really stems from the 1980s savings and loan crisis to try and limit banks' exposure to deposits that may have risk of flight and diversification. This diversification strategy could have helped some banks we used to know (SVB). So now CFOs are being urged to shore up the balance sheet quickly, and the fastest way to do that is to utilize the financial tools at their disposal: the Fed, Federal Home Loan Bank and brokered deposits that were created literally for this exact purpose. Yet now borrowing is also concerning folks; it seems like you can't win with the headlines. Or is it the regulators? Hard to tell. Regardless, now, after so much drama over uninsured deposits and FHLB checks, the spotlight has shifted to brokered deposits. Brokered deposit levels have nearly doubled year over year. Option A – Spend precious limited dollars on marketing that likely won't work to try to acquire customers outside of your footprint/core target market and then resort to brokered anyway. Or option B – keep focusing on your core competencies and borrow as needed in a tighter cash market; the potentially slightly higher interest rate will likely far outweigh the time and marketing spend. Then, once you have a calculated long-term strategy, execute it. I'd like to outline the common concerns with brokered deposits and some mitigation.

“High APY savings chasers are not the stickiest customers but they are THE most predictable.”

1. Higher Interest Rate - As I write this article, the rate on the FHLB website is 5.32% for one year; interestingly enough, the Fed Funds Effective rate is 5.33%; the market is aligned on the COF here. Now let's look at average non-termed savings rates; this is 0.61%; however, that is not a fair comparison; the FHLB borrowing is termed! If you look at average 1-year CD rates, they are ~5%, and you still have to acquire the customer; good luck doing that for 32 bps.

2. Higher Rate Sensitivity - Brokered deposits will generally cost the same as your savvy consumer will demand; FIs should just get used to it; gone are the days when you can get away with non-interest-bearing / ultra-low interest-bearing accounts. It is only a matter of time before everyone wakes up to the fact that their bank or credit union needs to pay something on their cash in order to keep it. This should play into the long-term plan: find a way to acquire the deposits that will be cost-effective in the long run.

3. Potential for Rapid Withdrawals - If the brokered deposits have a defined term, this is counterparty risk, not underlying consumer/depositor risk.

4. Regulatory Risk - You can't have a high LTD ratio, but also, you better not borrow too much, so damned if you do, damned if you don't.

5. Market Conditions - This is valid but can be mitigated; rolling maturity dates with funding need to be calculated, and there should not be major cliffs in deposits or unplanned gaps with no core deposit backstop. A long-term view of brokered deposits as a piece of the puzzle and as complementary to the core will bring extra comfort vs extra concern.

The icing on the brokered deposit cake is when there is an innovative solution; it could actually be labeled too good to be true. At my current company, Upgrade Inc., we have been successfully engaged in the loan-selling business for 6+ years, having facilitated over $23bn in credit since inception. Upgrade is also the servicer of all these loans, one of the keys to our business model. When liquidity became uncertain, and our 200+ bank/credit union partners struggled with funding for the income-generating loan programs they purchased from us, Upgrade was ready with a solution. We anticipated the need to address the funding aspect of the equation. In 2020, we launched Rewards Checking as part of the effort to solve the funding side. However, the arrival of the COVID-19 pandemic, the influx of stimulus money, and the subsequent liquidity tsunami meant little appetite for deposits. Nevertheless, we developed the necessary infrastructure to relaunch a high APY savings account by late 2022. Then, as demand for deposits soared, we were positioned to start sweeping brokered deposits to our loan-buying partners and, to date, have swept over $600M.

As we work with partners (both new and old) on balance sheet plans for 2024, we have heard the feedback our deposit program is "too good to be true." High APY savings chasers are not the stickiest customers, but they are THE most predictable. You raise the rate, you get more; you lower the rate, you lose them. They are generally highly diversified across industries and geographies. These customers are acquired digitally at a speed that few traditional depositories can compete with. The biggest distinction is they only come with a loan partnership. Upgrade's premier partners that purchase any of our personal loans, cards, auto, or home improvement products have access to the discounted deposit network. The idea of our offerings just below Fed Funds or FHLB being too good to be true adds to the nonsensical rationale of not utilizing brokered deposits for the exact reason they were created. The Upgrade-provided deposits are a way to lock in an NIM with a known cost of funds and a forecasted return. It is not free money; it is just discounted, but again, it is only available to those financial institutions still focused on generating net income and participation in the lending side of the business.

While we navigate and educate partners on our offering, it has uncovered many misconceptions about brokered deposits. The astute CFO will use brokered deposits as the arrow in their quiver to continue to focus on income-generating programs and advancing the financial soundness of their customers and institutions. This timely assistance will provide a cost-effective way for Financial Institutions to diversify and grow liquidity while giving them time to focus on long-term strategies.