Riding the Spread

Rising rates and increasing competition for deposits have also hurt banks, particularly those with a high proportion of fixed-rate loans. “Acquiring funds has become more expensive,” says Daniel Dwyer, senior vice president of the institutional strategies group at Minneapolis-based North American Capital Markets, LLC, which offers consulting services to financial institutions.

Worse, the rising rates have occurred in the presence of a flat or even inverted yield curve. In November 2006, the Fed funds rate stood at 5.25 percent for overnight loans. In addition, 10-year Treasury bills were trading at 4.52 percent. When banks pay more for short-term funds than they can expect to realize from longer-term loans or investments, Anderson says, “it’s a difficult headwind for the banking industry to overcome.” Minnesota banks are being forced to carefully manage interest rate risk via a variety of strategies.

Get Deposits

“Every day I tell my people that they have three concerns: deposits, deposits, and deposits,” says Michael Zenk, president of the Bloomington-based Venture Bank. Deposits are typically the least expensive source of funds for banks—cheaper than borrowing funds.

The search for deposits, however, isn’t just a quest for accumulation. Instead, banks work to attract only the deposits that they can reinvest at a higher interest rate than the one they pay depositors, putting the money into either a higher-rate loan or investment. “It doesn’t make sense to have high-rate overnight deposits that we’re just investing in overnight Fed funds,” says Gwen Stanley, executive vice president and chief financial officer at Venture Bank.

Even so, many bankers say that deposits aren’t as easy to get as they once were. Some consumers and businesses have moved cash into money market and stock funds, reducing the total amount of money available for deposit. And there is fierce competition for the money that’s left. “Everybody’s fighting for deposits,” Stanley says.