Bankers throughout the country are increasingly focused on both attracting properly-priced funds and creating more practical, customer-centric ways to retain quality deposits. It’s no secret that retaining appropriately-priced deposits is a more cost-effective proposition than chasing new funding. Financial institutions have invested greatly in core infrastructure and are hungry for better strategies to most efficiently leverage the tools they already have.
The FDIC Quarterly Banking Profile for Second Quarter 2015 reports that, nationwide, loan balances for community banks increased 2.7% from the previous quarter and are up 8.8% from the previous year. The 12-month growth rate for community bank loans was almost twice that of non-community banks and substantially higher than the 5.4% average for all banks. As loan demand increases and the Federal Reserve considers raising interest rates, bankers will inevitably be forced to manage both sides of the balance sheet more strategically.
One of the largest single sources of sustainable deposits for banks is still certificates of deposit (CDs). While the CD may strike some as a relic of days past, their importance has never been more relevant for stable funding strategies. Most community banks fund between 10% and 40% of their balance sheet with time deposits. CD retention management is even more important when you consider the broader relationship opportunities associated with these customers, who often have discretionary financial resources.
Retention Cliff
Managing a CD portfolio has long created a dilemma for bankers because of the “cliff” of certainty at the end of each term. In other words, customers come to a clear, almost perfectly predictable decision point as each CD matures: return or not to retain. The exercise often revolves around how CD monies are traditionally retained – through awkward rate negotiations – that can create stomach acid for even the most seasoned of front-line bankers, who earnestly want to maintain the customer relationship.
CDs are viewed by consumers in a very specific way, simply because of their definition and structure. It is typically a game of rate and term. Front line bankers dealing with rate-shoppers are often put in a match-it-or-lose-it position, causing tension and frustration for bankers and customers alike.
The good news is that better options are available. Indeed, financial institutions can create a third choice using the tools already in their operational toolkit, a win-win solution that gives the customer contact people a more powerful and practical method of working with customers to retain these deposits.
Consider a simple savings account specifically designed to retain maturing CD funds at reasonable interest rates that can be easily created on a bank’s core system. It offers customers yields comparable to currently offered CDs, but without term commitments or early withdrawal penalties. We realize this unconventional strategy may sound counterintuitive. After all, why would any banker want to offer savings accounts that pay CD yields?
First, consider the matter from the depositors’ perspective. Do they like competitive rates and liquidity? You don’t have to think long about that question to come to the obvious answer. Bankers, in turn, recognize that there is always someone willing to pay higher CD rates. However, with this savings account, they now have a chance to keep depositors satisfied without paying higher rates.
It’s important to note that this kind of account should never be promoted via direct marketing. Such an approach would be counter-productive, since we are talking about a product that is designed to defend deposits, not to attract new ones. Rather, this product is specifically designed as the retail bankers’ “ace in the hole,” or solution of last resort, when a current CD depositor has indicated that they believe none of the bank’s products are suitable for re-investing their currently maturing CD funds. Bankers can utilize this account when they recognize that the funds will be lost without being able to offer a viable, authorized alternative that doesn’t require a conversation with upper management or the chief financial officer to get approved.
What we’re referring to here is an exclusive, invitation-only product that can be offered to valued depositors with whom there has been a historically loyal relationship. This is not a tool for hot money. It is a solution designed to sustain quality banking relationships.
No Disintermediation
From the customer’s perspective, this type of account offers a competitive return, but also something equally important: liquidity. Once the funds are moved into this account, the customer can withdraw them at any time, giving customers the control they don’t have with CDs, although they still get a CD-level yield. The magic of offering this kind of solution is that the customer recognizes that the bank values their relationship. How so? Because they have been personally invited to take advantage of this exclusive, high-yield savings account.
The banker, in turn, gains a tool to move the conversation from a traditional, predictable and narrowly focused interest rate and term negotiation to something richer and of potentially greater value to the depositor. And the bank itself retains core deposits at reasonable interest rates.
Now for the secret sauce: deposits are prohibited. The account structure prohibits deposits and therefore eliminates the disintermediation of checking and savings funds. This is a familiar restriction to CD customers, who don’t expect the opportunity to deposit additional funds to their CDs and so don’t care. They are happy and the bank is protected from the fast money pain that is typically associated with high-yield money market accounts.
Customers are reluctant to withdraw funds from the special purpose savings account because they cannot replenish these funds without investing first in a CD and then later transferring to the account. Such a prohibition on deposits is critical to success because it eliminates possible disintermediation of other deposits and creates more stable, desirable value the customer will want to hold on to.
Another benefit of this offering is that, because these are not transaction accounts, operating expense associated with these accounts is minimal. The bank retains control of pricing this variable rate account, and although it should not be formally indexed, the pricing can be based on a predictable formula. With such an account, the bank has a better opportunity to price CDs profitably and use the accounts to retain a substantial portion of deposits that would otherwise leave at maturity.
Bankers have become so familiar with the CD product over the years that they often fail to look at it with “fresh eyes.” This is one of those situations when it might pay to utilize a different approach to avoid the traditional “cliff” dilemma associated with CD retention.
Mr. Stanley is CEO/founder of The CorePoint, an Omaha, Neb.-based firm offering a web-based retail deposit pricing and sales platform. He can be reached at [email protected]. Mr. Olan is CEO/founder of Houston, Tex.-based CAKE Performance Group, a strategic bank-growth consultancy. He can be reached at [email protected].
