Commercial Loan Automation
Small Business Banking
BirdsEye View2020 - 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:
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.