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BirdsEye View

2020 - year of the deposit

 Deja vu all over again -  the year of deposit gathering is coming back.  As loan growth continues to outstrip deposit growth, we’re all looking for ways to grow deposits.

In the early 2000s, the cost of borrowing, particularly FHLB borrowings, was so low that CFOs nationwide opted to fund their balance sheet growth through wholesale sources.  Core deposits were too expensive and were negatively margined to FHLB funding costs.

The absolute low level of the yield curve in those years also contributed to the perceived lack of profitability of deposits.  Many retail franchises were assigned loss numbers in banks’ P&Ls, as wholesale deposit sources were both cheaper to gather and commended lower interest expense.  The bloom was off the interest-free checking account rose.

CDs became the least attractive deposits, fixing interest rates as they declined and costing banks many a basis point.  Variable rate funding was the battle cry for all.

In addition to these trends, loan demand slacked off after the crisis as the economy slipped into a mild recession, followed by years of uncertainty.  The result was lower capital expenditures, lower borrowings against lines of credit, and overall lower loan demand.

These words were written in 2005, and history is repeating itself.  Things have changed dramatically in the past twelve months.  After six months of intense rate hikes and higher rate expectations, the Fed is loosening up again to stave off recession fears.  Economic activity picked up, including loan demand, and we’re seeing double-digit growth in loans, yet single digit growth in deposits.  Wholesale funding has become generally less attractive due to shifting regulatory requirements and liquidity definition as well as the heavy reliance on core deposits in bank valuations.  Banks nationwide have experienced loan growth in recent years which is outstripping deposit growth, and this is leading to taking a fresh look at deposits. 

We enjoyed a decade of heavy deposit flows into our business.  That, coupled with slow loan growth, allowed our industry to manage the deposit base much more effectively than in 2005-2007.  We shed unattractive, non-core CDs and grew core deposits across the board.  As loans started growing and rate rising, the loan rate beta was 80% of the rate rise, while deposit beta held at 20%.  Loan-to-deposit ratios were low, and funding abundant.

As banks filled their balance sheet with loans, including filling the CRE bucket, the need for deposits rose.  LTD among our members is nearing 100%, and the attention has shifted to deposits.  Interest-free checking accounts look more attractive than ever, yet customers have awakened to rate differentials after last year’s wild rate ride. Deposit betas were 31% in much of 2017 for interest bearing deposits and 22% for total deposits, as compared with 50% and 40% respectively between 2004-2006 and today. 

The massive shift by so many banks to rediscover deposits has created intense competitive and pricing pressures.  This trend coincides with the rising importance of the digital experience, which gives the universal banks a strong competitive advantage.  Many community banks are refueling price competition by introducing the usual odd-maturity CD or a high-rate MMA.  Some are rekindling the free checking fires. New customer acquisition is also at a premium.  The industry is experiencing a common quandary:  how to grow deposits, especially core deposits, when the bank next door is bidding up deposit prices, offering significant cash amount for checking account openings ($500 per account is now commonplace, and some offer $1,000) and appears to be destroying the pricing discipline in the marketplace?

The answer to the deposit growth question isn’t easy.  It starts from the basic tenets of deposit pricing, which the universal banks have figured out some time ago, but many other banks haven’t focused on fully yet.  Most large banks have already picked a point on the pricing range they’d like to be on, and stay true to it almost at all times.  Some large banks with a significant network advantage, i.e. those who have good branch coverage in a market, consistently price below market rates, since they offer superior convenience that helps attract depositors.  Further, as the definition of convenience shifts more toward the digital experience, this advantage is amplified, especially among younger prospects.

Many banks have not articulated internally nor externally their deposit pricing position.  Many aren’t sure whether they wish to be at the top of the market or bottom quartile.  As a result, the marketplace, including customers and prospects, isn’t sure what their pricing position is and what to expect from future deposit pricing activities.

The first step toward an effective deposit gathering strategy is for the bank’s senior management to decide where on the pricing continuum they want to be, and then fulfill on that promise consistently.  For example, some banks are known to chase “hot” money.  Their customers know that they are likely to get the best price in the market, and remain loyal without much shopping throughout rate cycles.  This is a valid position, although an expensive one, to take.  It is also a “tar baby”, because once you embark on that merry-go-round, it is very difficult to get off it.  Others choose different rate curve positions, such as not competing on price but on other variables, are equally valid and often more profitable. 

Once a global deposit pricing strategy has been set, there is much flexibility within this framework to achieve deposit growth in different customer and price segments.  Here are some thoughts:

  1. For geographically-diverse banks:  price more aggressively in low-cost markets and lend more aggressively in high-yield markets.  For example, a bank with branches in the west coast and loan activities on the east coast will be best serve to generate more deposits out west and more loans out east, since the east coast has traditionally been a more expensive market for both loan and deposits than the west coast.  While most banks do not have this geographic span, they do have pricing disparities within their markets.  Identifying those disparities and targeting low-cost geographic pools for deposit gathering is a winning strategy.

  2. Focus on low-cost populations: certain customer segments are less price-sensitive.  They look for other value drivers, such as convenience, true service differentiation, digital solutions, personal service or one-stop financial solutions to name a few.  These customers are willing to give up some price differential in order to receive the elements they value more.  Surprisingly, certain wealth management clients define value as a much more complex proposition than price alone, yet they have large deposits under their control.  Other examples are abound. These low-cost populations are typically not huge, and require specific targeting, segmentation and pricing work.  However, the pay-beck can be significant.

  3. Develop products that encourage deposit aggregation: Banks have been bound too long by unyielding technology that impedes them from offering true relationship pricing.  The time has come for this advancement, and certain banks are moving in that direction more rapidly than others.  In general, most banks do not give their customer a financial benefit for being loyal and aggregating their deposits in one spot.  Relationship pricing, i.e. increasing yields as the customer builds deposits with the bank, is an idea whose time has come.  It is up to us, the banks, to give our customers a reason to do more with us beyond just telling them how great we are.  Relationship pricing is one answer. Note:  The FIS RVA product is an attempt to move in that direction, but its complexity often causes too much confusion among both bankers and customers.

  4. Do not get hooked on those odd-maturity specials:  Off maturities are in vogue again.  7, 11, 13 months CDs are offered by many banks who are looking to grow deposits without having to price their entire portfolio. This strategy is effective, but it is also addictive.  Those deposits will come back home to roost as they mature, and the improved rate will be part of the customer expectation for renewal.  Also, so many other banks have figures out this simple solution and are following it, such that odd maturities aren’t that odd anymore. This tactic is a double-edge sword, and needs to be evaluated carefully in the overall strategic context of the institution and its desired balance sheet structure.

  5. Bring your sales culture to bear:  Many banks are boasting of their sales culture and how far they’ve come, yet when it’s time to leverage that investment by gathering deposits without a price premium the sales force fizzles out.  The definition of a sales isn’t a giveaway; it is about meeting customers’ needs without compromising the needs of other constituencies, such as the shareholders.  A true sales culture means that your folks are better than other banks’ in finding out what customers really need and giving it to them, offering a complete value proposition of care, service, price and other elements on the customer’s terms.  I have not seen many examples of the sales culture paying off as described above, but a bank with a true sales culture will be able to capitalize upon the investment in building it by mobilizing their bankers to sell customers more deposits than they have ever done. Note:  In the Wells Fargo aftermath, sales culture has become a dirty word. I still believe that needs-based selling is what we should all be engaged in, as its first step is DO THE RIGHT THING – for customers, shareholders, communities and employees.

  6. Focus on high-average balance segments:  Some segments offer higher balances than others, yet many of those segments are under the radar screens of the mega banks, or aren’t in the center of competitive pressures.  Small business is an example of a neglected segment that is deposit-rich and potentially very loyal.  It is the bread and butter of quite a few banks whose interest free demand deposit to total deposit ratio exceeds 35%.  The mega banks have specialized deposit sales forces that cater to this segment, but they can’t offer the relationship orientation that other banks tout as their competitive advantage.  This segment is a perfect target for relationship banking.  Those that have executed well on this proposition have not experienced the same margin compression that others have, and are often in a margin expansion mode, due to a high percentage of true core funding.  This is one example of the leverage opportunities that community banks need to capitalize upon.

  7. Focus on specific segments, including industries, ethnicities etc., as target markets:  Certain ethnic groups have strong saving culture.  There are banks that dedicate themselves to gathering those deposits, such as the Asian banks that have been sprouting and growing across the country.  Hope Bank is an excellent example of the success of this strategy.  Other banks become multi-cultural, go beyond their core ethnic group, and serve several high-savings customer segments.  In Chicago, for example, the banks that serve the Ukrainian and Polish communities  have continued to experience deposit growth beyond the city’s average since they targeted deposit-rich segments that aren’t on everyone’s “hot” list.  Every market has such opportunities; it is up to each bank to focus on these opportunities and execute well by creating trust and a comfort level among the target segment’s population.  Similarly, certain industries are deposit-rich, and focusing on them with true understanding of the business and value-add go-to-market approach is a valid strategy.

  8. Incentivize your customers to remain with you:  Banks strive to achieve customer retention, since it is the best predictor to future earnings growth and stability.  At the same time, customers rarely get “retention bonuses”, unlike coveted employees, who do. Banks have developed golden handcuffs to support employee retention, as well as bonus structures to achieve the same result.  Why not do so with those very special customers? Why not offer differential pricing to reward loyalty, tenure, etc.?  There is much banks can learn from the airlines’ loyalty programs in this regard.

  9. Proactively nurture your best customers.  We are loathe to reach out to sleepy money customers and awaken them by offering rate concessions.  At the same time, rate-sensitive customers feel let down when their own bank “takes advantage” of their passive posture without proactively acknowledging rate movements.  It’s a tough balance to strike between fairness to customers, delivering on our brand promise of trust and not penalizing our shareholders by offering rates that are too high.  Yet, as we think about doing the right thing, we cannot leave our most loyal rate-sensitive customers to fend for themselves.  If we want them not to shop for better rates, we need to show them their trust in us has not been misplaced.

  10. Make switching costly.  Switching banks can be a costly move for customers.  In addition to the annoyance and aggravation associated with such a move, there are other costs: 
  • Transaction costs:  the direct costs of starting a new relationship (such as ordering new checks, for example)|

  • Learning costs:  Developing a comfort level with the new bank’s website, mobile app, products, operations etc., such as learning ATM locations, phone tree information or a new online bill payment process

  • Contractual costs:  Some banks impose penalties on customer defection or simply make it harder to leave.  For example, automatic direct deposit of paychecks is difficult to unwind.

    The higher the switching costs, the longer a customer stays with you. 

Customer retention drives deposit growth.  One major bank’s statistics indicate that 25% of the customers drive 85% of the dollar attrition.   The opportunity to curb the tide among existing customers’ attrition is huge.  Calculating what 1% deposit retention is worth to the bank is a first step to inspire all to ensure customer retention is at a minimum.  This is one of the more important lessons that can facilitate deposit growth.

Consider these facts:

1.  70% of all new money in most banks comes from existing customers. 

2.  There is a direct and positive correlation between tenured employees and tenured customers.  In other words, employee retention leads to customer retention.  Similarly, engaged employees lead to engaged customers.

Both these facts offer opportunities for deposit growth.  The first implies that, short term, the best source of new money is existing households.  Yet, they are rarely the subject of major marketing campaigns.  Most of our attention is directed to acquiring new customers, not cross-selling existing households.  Banks that will redirect some of their attention to building existing relationships will experience faster deposit growth at lower rates than those who are exclusively hunting for new accounts.  UMB is a great example of such strategy that paid off handsomely.

In the longer term, the second fact is most meaningful.  It implies that as banks work to retain their own employees and reduce turnover, the customers will follow.  Yet employee retention isn’t at the forefront of many HR directors.  A cohesive program to improve employee retention isn’t easy to execute, but the long-term payoff is significant across all fronts:  customers, employees, and shareholders.

Deposit gathering is the challenge of the moment.  The solutions are many, and those who think out of the box and develop their own original answer to the problem will do the best.  There is nothing wrong with borrowing great ideas from others’ success, but being Last In and Last Out in any initiative won’t pay off.