Pub. 7 2018 Issue 6

faster pace, banks likely will not be able to fully deploy the additional funds generated by tax reform. The windfall from tax reform will leave banks; which, already believe they have excess capital, flushed with even more funds. Bankers expect the industry to use the newfound capital to go on the offensive and have warned investors not to expect all the savings from tax reform to fall to the bottom line. Some investors have incorporated heightened competition into their thinking. They have noted that when banks receive an influx of capital, they tend to use the funds to take market share. Some investors do not expect the response to tax reform to be any different. Banks can take market share through superior service, but they often do it by offering lower prices. Deposit Competition Heating Up As community banks look to put more liquidity to work, their funding pressures and deposit costs will grow, albeit at a slower pace than their larger counterparts. Community banks’ cost of interest-bearing deposits only rose modestly to 0.53% in 2017 from 0.46% in 2016 despite a trio of rate hikes from the Federal Reserve. Community banks recorded a deposit beta, or the percentage of changes in rates they passed on to customers, of just 11% in 2017, well below the roughly 20% beta recorded by the banking industry as a whole. Community banks have historically lagged increases in rates by greater amounts than their larger counterparts, and while that trend should continue, the gap is expected to narrow. Interest-bearing deposits should become larger portions of banks’ funding bases and eventually revert back to the relative size on community bank balance sheets witnessed before the Fed lowered short-term rates to historical lows. S&P Global Market Intelligence expects that deposit costs will rise at a faster pace in 2018. The projections assume a beta of 33% on interest-bearing deposits in 2018 and expect that beta to increase to 44% in 2019 after the impact of higher rates takes hold and funding pressures grow. Community banks will be able to offset some of the increases in deposit costs as earning-asset yields expand. Further increases in long-term rates will help security yields continue to rise, but some of the benefits will be mitigated as community banks have reached further out the yield curve to bolster income while rates remained low. The extension of bond portfolios in recent years means community banks will have to hold lower-yielding securities for longer periods of time. Loan yields will also expand materially, but the benefits from higher rates will be somewhat mitigated by the competitive environment, particularly in 2020 and 2021 when credit quality is expected to sour. The increases in yields will occur while funding costs remain relatively low, allowing for margins to rise over the next few years before rising competitive pressures stand in the way of further expansion. Community bank deposit betas poised to rise off historical