Core Deposits

• The Bottom Line: Core deposits are a bank's secret weapon—a stable, low-cost source of funding from loyal customers that creates a powerful competitive advantage and a significant margin of safety.
• Key Takeaways:
• What it is: The “sticky” money in regular checking and savings accounts held by individuals and small businesses, which is less likely to leave when interest rates change or the market panics.
• Why it matters: It provides a bank with cheap and reliable funding, which fuels higher profitability and creates a durable economic_moat against competitors.
• How to use it: Analyze a bank's financial reports for a high percentage of non-interest-bearing deposits, a low overall cost of funds, and a high proportion of accounts under the FDIC insurance limit.

Imagine two builders, both tasked with constructing a skyscraper. The first builder, Mr. “Hot Money,” decides to build on a sandy beach. He gets his foundation materials (sand and gravel) very quickly and cheaply from a temporary supplier who is offering a one-day-only special. The skyscraper goes up fast, and it looks impressive. The second builder, Ms. “Value Investor,” chooses to build on solid bedrock. It takes her much longer to excavate and lay a deep concrete foundation. Her materials come from a long-term, trusted supplier who has been a partner for decades. Her process is slower, less flashy, but infinitely more stable. Now, a storm rolls in. Which skyscraper do you think will remain standing? In the world of banking, core deposits are the bedrock foundation. They are the stable, loyal, and low-cost funds that regular people and local businesses keep in their checking and savings accounts. This isn't “hot money” chasing the highest interest rate on the internet; it's the money used to pay mortgages, cover payroll, and buy groceries. It's “sticky”—it tends to stay with the bank through thick and thin because of convenience, trust, and long-standing relationships. Non-core deposits, or “hot money,” are the sandy beach. This includes large, uninsured Certificates of Deposit (CDs) from corporations, money from institutional investors, and funds from brokered deposits—all of which will flee to a competitor for an extra 0.1% interest or at the first sign of trouble. A bank built on this sand is fast-growing but dangerously unstable. As a value investor, you aren't interested in flashy skyscrapers on the beach. You're looking for the bank that meticulously built its foundation on solid rock.

“The banking business is very good if you don't do anything dumb… It's a commodity business, largely. It's very hard to get people to leave their bank. Inertia is a huge force in banking. But you have to be the low-cost producer. And the way to be the low-cost producer in the banking business is to have a lot of cheap deposits.” - Warren Buffett

For a value investor, understanding a bank's deposit base isn't just an accounting detail; it's a primary indicator of its quality, durability, and long-term viability. It directly informs our assessment of the bank's intrinsic_value and, crucially, its margin_of_safety. Here’s why it's so critical:

• The Ultimate Economic Moat: A large base of core deposits is one of the most powerful and durable economic moats a bank can possess. It represents a massive network of customer relationships built over decades, often branch by branch, handshake by handshake. A new online-only bank can't replicate this overnight simply by offering a high-interest savings account. This low-cost funding advantage allows the bank to either offer more competitive loan rates or, more likely, earn a higher profit margin than its rivals.
• A Built-In Margin of Safety: The 2023 banking crisis, which saw the collapse of Silicon Valley Bank (SVB), was a masterclass in the importance of core deposits. SVB relied heavily on large, uninsured deposits from a concentrated group of tech startups. When fear struck, this “hot money” vanished in hours. A bank with a granular base of millions of small, FDIC-insured checking accounts would have weathered that storm with far greater ease. These sticky deposits provide immense stability during panics, acting as a crucial shock absorber and a source of strength when others are weak.
• The Engine of Profitability: The fundamental business of a bank is simple: borrow money at a low-interest rate and lend it out at a higher rate. The difference is called the net_interest_margin (NIM), and it's the bank's primary source of profit. A bank with a mountain of core deposits (many of which, like checking accounts, pay 0% interest) has a structurally lower cost of funding. This gives it a permanent head start in the profitability race.
• A Signal of Trust and Quality Management: A strong core deposit franchise doesn't happen by accident. It is the result of a management team focused on building genuine, long-term customer relationships rather than chasing short-term, high-risk growth. It signals a conservative, prudent, and customer-centric culture—all hallmarks of a business that a value investor can admire and own for the long run.

There isn't a single line item on a bank's balance_sheet labeled “Core Deposits.” Instead, as an investor, you must act like a detective, piecing together clues from the bank's financial reports (like the 10-K and 10-Q) to assess the quality of its deposit base.

Here’s what to look for and where to find it:

1. 1. Find the Deposit Composition: Look in the footnotes of the 10-K report for a table that breaks down deposits by type. You want to see a high percentage of “non-interest-bearing demand deposits” (i.e., checking accounts) and low-cost savings accounts. A high reliance on “time deposits” (like large CDs) is a red flag.
2. 2. Calculate the Cost of Deposits: This is a crucial metric. The bank's income statement will show “Interest Expense.” You can find the total average deposits in the financial tables.
   • `Cost of Deposits = Total Interest Expense on Deposits / Average Total Deposits`
   • A world-class bank like Bank of America or Wells Fargo might have a cost of deposits well below 1%, while a less-advantaged bank might be paying 2% or more. This difference is enormous for profitability.
3. 3. Check for Insured vs. Uninsured Deposits: Since the SVB crisis, most banks now explicitly disclose the percentage of their deposits that are under the FDIC insurance limit (currently $250,000 per depositor). A higher percentage of insured deposits is a powerful indicator of stability. A number above 60-70% is generally considered strong.
4. 4. Analyze the Loan-to-Deposit Ratio (LTD): This ratio shows how much of the bank's lending is funded by its deposits.
   • `Loan-to-Deposit Ratio = Total Loans / Total Deposits`
   • A ratio below 100% (ideally in the 80-90% range) is healthy. It means the bank is funding its loans with its stable deposit base and isn't overly reliant on more volatile wholesale funding. A ratio consistently above 100% is a major warning sign.

A single data point is useless. The key is context and trends.

• Comparison: How do these metrics stack up against the bank's closest competitors? A bank with a 0.5% cost of deposits is fantastic, but if all its peers are at 0.4%, its advantage is smaller than it appears.
• Time Series Analysis: How have these metrics changed over the last 5-10 years? Is the percentage of non-interest-bearing deposits shrinking? Is the cost of deposits creeping up faster than its peers during a rising rate environment? A deteriorating trend can reveal a weakening moat.

A high-quality banking franchise will consistently exhibit a lower cost of funds, a higher percentage of non-interest-bearing deposits, and a more stable deposit base through all phases of the economic cycle.

Let's compare two hypothetical banks: “Bedrock Community Bank” and “Momentum Internet Bank.”

Analysis: At first glance, both banks have the same amount of deposits. But a value investor immediately sees the enormous difference in quality.

• Bedrock Community Bank is a fortress. A full 35% of its funding is free (non-interest-bearing). Its overall cost of funds is incredibly low at 0.75%. Its deposit base is overwhelmingly composed of sticky, insured accounts, and it comfortably funds all its loans with these stable deposits. This bank is built to last and will likely be highly profitable over the long term.
• Momentum Internet Bank is built on sand. It has almost no free funding and must pay a high price (2.50%) to attract and retain deposits. The majority of its deposits are large and uninsured, meaning they are likely to flee at the first sign of trouble. Worse, it is lending out more money than it has in stable deposits, forcing it to rely on even more expensive and fickle wholesale funding. While it might be growing quickly, its business model is inherently fragile and risky.

A value investor would overwhelmingly favor Bedrock Community Bank, even if it were trading at a slightly higher valuation multiple, because its economic_moat and margin_of_safety are vastly superior.

• Indicator of Stability: A strong core deposit base is one of the best single indicators of a bank's resilience during a financial crisis.
• Proxy for Moat Quality: It provides a quantifiable way to measure the strength of a bank's competitive advantage and its customer relationships.
• Driver of Profitability: It directly translates to a lower cost of funds, which is the primary engine of a bank's long-term profitability and ability to generate shareholder value.

• Fuzzy Definition: While we have good indicators, there is no universally agreed-upon accounting definition of a “core deposit,” and management teams might present their deposit base in an overly favorable light.
• Environment Matters: The advantage of cheap funding is more pronounced in a high-interest-rate environment. In a zero-interest-rate world, the profitability advantage narrows, though the stability advantage remains.
• Not a Guarantee of Safety: While a strong core deposit base is a massive defense, a severe, system-wide panic can still cause runs on even the strongest banks. It is a necessary, but not always sufficient, condition for safety.
• Requires Deeper Analysis: Simply looking at the headline numbers isn't enough. An investor must understand the local economy the bank serves, the competitive landscape, and the quality of the management team.

• economic_moat
• net_interest_margin
• margin_of_safety
• balance_sheet
• risk_management
• intrinsic_value
• circle_of_competence ¹⁾