How Huntington Bancshares Found the Holy Grail of Banking

It's the Holy Grail of banking: non-interest demand deposits. 

These are deposits that a bank does not have to pay any interest on. When your business model depends on the interest spread between deposits and loans, such deposits can be hugely profitable.

That's the very thing that Huntington Bancshares (NASDAQ: HBAN  )  is finding out as it has grown its non-interest demand deposits by 190%.

Flickr // Eddi van W.

A quick history
In 2007, on the eve of the financial crisis, Huntington's non-interest demand deposit levels weren't horrible. They made up a respectable 14% of total deposits.

However, there was still cause for concern. Costly wholesale deposits, like large CDs, made up about the same amount of the bank's deposits. Its overall loan-to-deposit ratio, a balance sheet risk measure, was 107%.

It should be kept in mind that although fewer wholesale deposits are generally preferred, a higher loan-to-deposit ratio isn't necessarily a bad thing.

Many thrift institutions commonly have ratios exceeding 100%, but they also have portfolios that compensate for the added risk brought on by extended leverage. For a bank like Huntington, however, the typical safe zone is between 70% and 85%; 107% was bad news.

It was an indication that the bank was taking on more risk than it should, likely in an effort to make up for a higher dependence on costlier deposits. This risk level was confirmed by the nearly $2 billion in bad debt that plagued the bank just two years later.

What's changed?
The financial crisis was a cathartic experience for Huntington's balance sheet. Not only was the bank able to clear bad debt from its assets, but it also refocused the way in which it would make future loans.

The loan-to-deposit ratio has since come down to a more acceptable 90%. In fact, the whole liabilities side of the bank's balance sheet has taken on a new composition.

To begin with, the percentage of deposits making up the liabilities side of the balance sheet has increased to 92%. This reflects support for sustainable loanmaking activities.

The deposits that make up this increase are cheaper as well. In addition to the 190% increase in non-interest demand deposits, reliance on wholesale deposits has shrunk by 50% over the last seven years.

Overall, 95% of Huntington's total deposits now belong in the highly desired core deposits category, greatly expanding the bank's ability to cheaply make loans.

How the bank did it
The restructuring can be traced to two large-scale efforts by the bank.

The first is an extensive marketing campaign. Thanks to an advertising budget that has more than doubled since 2009, customers in every corner of Huntington's six-state area can hear all about its appealing Asterisk-Free Checking and 24-Hour Grace on overdraft fees.

The second is an internal effort by the company to boost cross-selling. As of 2013, more than two-thirds of consumer customers use four or more Huntington products like savings, money market, and other deposit-attracting vehicles.

The future of lending at Huntington
By increasing non-interest demand deposits, the company has set the stage for increased profitability in its loan operations.

Of course, it's important to keep in mind that you shouldn't just accept higher profits at face value. Increasing the interest spread allows for a wider allowance of error in other parts of the bank while masking it with continued profitability.

The shrewd investor would be wise to keep an eye on Huntington's efficiency, especially in its operating expenses. For now, sit back and bask in the glory of Huntington's Holy Grail.

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