Time Deposits: Profitable or Not?
Today, your bank is issuing time deposits at rates significantly below what they were just a few years ago and renewing CDs at a lesser rate than they were just last term. So, what’s the goal? Should bankers be pleased when they find that CDs renewed at 20 basis points below last term’s rate? Does it matter if the volume is shrinking or growing? How should the term-to-maturity of your newly booked CDs impact your assessment of their profitability? How can you make decisions about CD pricing and know that your measurement process will consistently help you understand if those decisions are contributing to or detracting from your bank’s profitability?
Many bankers will point to current cost-of-funds when asked about their bank’s funding performance. To declare that your bank’s funding is well managed because your cost-of-funds is declining today is superficial and dangerous. While cost-of-funds is certainly a relevant accounting measure, it doesn’t help us understand if the pricing decisions made last month regarding funding are contributing to profits, and if so, to what extent.
The solution is simple. We need to measure newly booked CD performance consistently. Without a measurement method that is capable of assessing the contribution to profit of the current activity within our portfolio, bank leadership has no legitimate way of gauging success.
The solution must measure and track volume, term and spread of newly booked CDs.
Funds Transfer Pricing Methodology
Assessing volume as part of performance is obvious. Without volume, spread is meaningless. To assess the value of time deposits, we must have a benchmark that considers term. Funds transfer pricing methodology is essential to monitor not just yields, but spreads. Without a funds transfer pricing methodology, we are left with an apples-to-oranges comparison. With funds transfer pricing we consistently focus on spread to the comparable term market index as our measure of pricing.
Term not only plays a role in selecting the comparable market yields; it is needed in the last essential step of the process to measure spread. Bankers intuitively understand the need to weight the results based on dollar volume. For example, if there are variances in pricing and size, simple averages of the cost of large and small deposits together distort their effective impact on the bank’s performance.
When it comes to time deposits, we must take this weighting process one step farther. Instead of weighting the spread only by dollar volume, the consistently appropriate measurement weights the spread by dollars and term. This simple but important step helps to robustly assess current pricing and sales process results as the benefits of longer-term victories and the hindrances from longer-term mistakes caused by current pricing and sales efforts are duly considered.
Measure and track your bank’s newly booked CD performance results by using reports generated from these six data fields: branch, balance, APY or rate, maturity date, last renewal date and original creation date. With this data and current market yields such as Federal Home Loan Bank advances, your bank can create reports showing count, volume, weighted average term, weighted average APY/rate, spread weighted by “dollar-months,” and the mix of auto renewed and not-auto renewed CD production for the month. Plotting volume and spread weighted by “dollar-months” will clearly reveal the contribution to profitability your bank is getting from its recent management of time deposits.
What does this cost? Nothing, beyond a little time to get the data extract and run a spreadsheet. How long does it take? Is today soon enough for you?
Without taking and tracking these measurements a significant piece of your managerial effectiveness is left to circumstance. When tracking these results, your bank will find, as in other areas of business, that what is measured can then be better managed. How much difference would a few basis points on the cost of your CD portfolio make on your return on equity? Isn’t it time you know the profitability that is coming from your current pricing and sales efforts in regards to this significant part of your balance sheet?