3 Ideas for Your Deposit Strategy

The 2022-23 Fed monetary tightening caused disruption to our depositor base. We either lost deposits to Treasuries, money market mutual funds, or disintermediated into higher cost deposits within our bank. In this video short, I suggest three ideas to improve your deposit strategy as follows:

1. Identify "dead money" in your depositor base and pro-actively deepen your relationship with them.

2. Create "companion accounts", as described by our friend Neil Stanley from The CorePoint, to lure the money we've lost back into our bank.

3. Manage the mix. Determine which accounts are "accumulation" versus "store of value."

Listen to the three-and-a-half-minute video for greater context. Or contact me at jmarsico@kafafiangroup.com or 717.468.3208. 

What are your ideas for a deposit strategy? 

Bankers: Who Has These Three Drivers of Value?

Two years ago bank stock analysts from investment banking firm Boenning & Scattergood identified three attributes in a financial institution that investors should look for. I wrote a blog post on it that is currently my third most read post of all time.

The three attributes were:

1. Superior Growth Prospects

2. Excess Capital

3. Strong Deposit Franchises

I can get behind these three. Can you?

Who Has "It"?

In 2018, I searched for individual financial institutions that met each of these criteria. In this post, I would like to search all publicly traded financial institutions between $1 billion and $10 billion in total assets to ensure I get adequate trading volumes to be able to compare trading multiples of banks that qualify as having these attributes and their financial performance. This resulted in 292 financial institutions (the "Measured Banks").

From there, I defined superior growth prospects as top quartile asset growth over a three year period. I defined excess capital as top quartile tangible equity to assets for the most recent year ended 2019. Strong deposit franchise was defined as top quartile non-interest bearing deposits to total deposits for that same period. 

The following table identifies all of the financial institutions that met at least two of the three criteria.

Bankers: Is It Worth Buying Checking Accounts

At least somebody noticed. Noticed that I might be a valuable checking account customer. Aside from credit cards, I don't get much attention from bankers or financial advisors. Maybe the "do not call" list is more effective than I thought?

So when I opened my mailbox and received the bribe, I was interested. Interested to see how much a bank was willing to pay for my business. The answer: $300 (see picture). Thanks Santander! Or should I say, gracias! I should note that Santander has a branch in my town. Courtesy of their Sovereign Bank bailout, ummm… acquisition.

I've heard opinions on whether a community bank should buy checking accounts. Sure, the big banks seem to be on the bandwagon. Jeff For Banks readers likely get these offers. One bank controller opens accounts for all offers and gladly takes the cash. A community bank head of consumer lending recently told me he did the same with a Key Bank offer. Five hundred bucks! Key Bank values him more than mi banco values me.

Is It Worth It?

If you're a regular reader, you know me. And my philosophy that it all comes down to a spreadsheet. So I ran the numbers to see if offering me trescientos dolares was worth it to Santander. Below are the results.

The analysis is assumption driven. For example, I assumed that the annual marginal cost of my checking account to Santander was $100, which included items fees and per account fees charged by their items processor and core processor. A guess, of course. But one based on my experience and my own checking volume.

I also assumed the credit for funds, which is also the spread for a non-interest bearing account, which this offer was for, was the same spread as for all community banks that subscribe to my firm's profitability outsourcing service. The spread of 2.52%, taken from an FHLB yield curve, would be the equivalent of 5.75 years duration based on FHLB Boston's spot rates at the time of printing.

Sorry for the technical stuff, but my finance readers would want to know.

And 5.75 years seems like a reasonable duration for such an account. In other words, the bank thinks they can keep that account for that amount of time. Also, I used the average balance per account for my firm's profitability clients. You can calculate your own bank's average balance for similar accounts.

So, Is It Worth It?!

The above spreadsheet would indicate yes. But wait!

It does not include the cost of the campaign. And that cost must be spread over the number of accounts opened. So, if the campaign went to 50,000 households, with a 2% success rate, that would equate to 1,000 net new accounts. And I'd like my marketing friends to chip in, but 2% seems a stretch. 

If the campaign cost $50,000, and you opened 1,000 accounts, then it cost $50 in incremental cost per account. Still worth it. But if you solicited 10,000 households, and experienced a 1% success rate, you would only open 100 accounts. If that campaign, which sounds more realistic for a community bank, cost $25,000, then it would cost $250 per account, erasing the present value of all profits.

This is why, in my opinion, you see large banks doing larger campaigns to generate economies of scale in terms of fixed acquisition costs (cost of the campaign). And it is much less common in community banks, which do not enjoy the benefits of scale of campaign.

So, my answer is... it depends. But it is all about the math.

Does my math work for you?

~ Jeff

Financial Institutions: What Drives Value v2

In a follow up to my last post on the subject, that was driven by my friends from Performance Trust, I was asked in the comments section of that post if there was a correlation between non-interest bearing checking accounts and price-to-tangible book multiples.

That nugget was asked by Mike Higgins, a bank consultant from Kansas City, who penned a guest post on these pages in the past. Rather than answer Mike in the comments, I opted for the wider audience distribution of a standalone post.

It's my blog. I can do what I want.

I am somewhat limited to how financial institutions report their deposit mix. Call report categories are easiest, and the closest metric is transaction accounts to total deposits. I thought this would give us what we needed.

So, is their a correlation between a bank's relative level of transaction accounts to their price-to-tangible book trading multiple?

See for yourself.

The data, courtesy of S&P Global Market Intelligence, is all publicly traded US banks with trading volumes greater than 1,000 shares per day, and that have non-performing assets to total assets less than 2%. That filtered out most of the very small, inefficiently traded financial institutions, and those with asset quality issues. I also eliminated banks that had NA in the transaction accounts/total deposits ratio.

The filters resulted in 306 financial institutions, which I divvied up into quartiles based on transaction accounts to total deposits. The top quartile, with 56.78% transaction accounts to total deposits traded at 208% price to tangible book at market close on October 4, 2018. The bottom quartile, with 24.71% transaction accounts to total deposits, traded at 145% price to tangible book. The line is linear. Which reads funny as I proofread.

So I would say: yes, community bank investors reward banks funded with a higher proportion of checking accounts with greater trading multiples. So when I wrote in June 2018, in a post titled Branch Talk, my Point 1 was that banks needed to build a cost of funds advantage by having a relatively higher proportion of checking accounts, the above chart is why.

In reviewing the data that fed the above chart, size was likely not a significant issue. All of the numbers above are medians, not averages. And the median asset size from bottom quartile to top were: $1.6B, $2.2B, $3.2B, $2.1B. Wells Fargo and JPMorgan, the nation's largest FIs, were both in the 3rd quartile.

A bonus table:

So there is a neat line in Return on Average Assets too. Price to earnings is not so neat, but I find it rarely is. Still, the message is clear. More checking, better performance, higher trading multiples.

Do you see it differently?

~ Jeff

Are Bank Products Simple, Fair, and Transparent?

I was on a road trip discussing banking with a colleague, and I mentioned that bank products are anything but simple, fair, and transparent. He said, “sounds like a blog post.”

I have never heard a bank customer say, “gee, I wish my bank relationship was more complex.” Yet we charge business checking fees based on a complex analysis, offer a 7-month special CD only to roll it into a lower yielding 6-monther if the customer isn’t attentive, and require high-interest checking customers to have 10 debit transactions, e-statements, and a partridge in a pear tree to get that rate. Sound simpler, fairer, and more transparent?

On the other side of the coin, bank customers don’t necessarily understand what it takes to run their accounts profitably. Dear customer, the Federal government requires financial institutions to monitor your account for suspicious activity and report anything untoward. That costs time and resources that drive up the cost for your checking account. That is why every overdraft fee, interchange transaction, and minimum balance fee counts. Your government drives up bank costs.

It costs $423 per year for a bank to run a retail interest-bearing checking account, based on my firm’s product profitability database. To cover that cost solely on the spread that your balances generate would require an average balance of $21,363 in your account. All. The. Time.

I have written on these pages that I thought the past practices of relying on customers to be asleep at the switch and accept rates significantly different than market rates will soon be over. Banks must shift business models to pay depositors something closer to market rates for “accumulation accounts”, which are accounts for long-term savings such as an emergency money market account, or a CD ladder.

Cost of funds advantages should be built on having relatively higher “store of value” accounts such as checking, or special purpose savings where convenience and safety are more important to the customer than accumulation.

So I don’t point out a problem without proposing a solution, I have an idea for a Simpler, Fairer, and more Transparent small business banking deposit product. Call it the Jeff For Banks (JFB) Business Banker Account. As I mentioned in past posts, I’m a narcissist and I’m trying to get something named after me.

JFB Business Banker Account

The product is a combined store of value checking account, and an accumulation money market and/or sweep account. But no sweep here into a repo where we have to pledge investment securities against balances. That wouldn’t meet the simple test.

Banks can pay businesses interest on their checking accounts. So I propose banks segment business checking accounts by their resource utilization, and create minimum balances based on this segmentation. So the college bar that drops off bags of money each morning at the local branch has a higher threshold before it doesn’t get charged a monthly maintenance fee and receives interest.

So the average balance for high utilization quartile account might be $70,000, above which the account receives a competitive interest rate, and below which the account is charged a monthly maintenance fee. Here is what the math might look like for Pete’s Corner Bar.

JFB Business Banker Account Profitability Estimates
1	Average Balance	$92,102
2	Checking Average Balance	70,000
3	Checking FTP Spread*	1,463
4	Money Market Average Balance	22,102
5	Money Market FTP Spread*	197
6	Total Account Spread	$1,660
7	Fees**	$540
8	Annualized Operating Cost per Account*	$784
9	Pre-tax Profit	$1,416
10	Pre-tax ROA	1.54%
11	Equity Allocation*	1.00%
12	Pre-tax ROE	154%
13	Total Account Cost of Funds***	0.30%
*Per TKG product profitability peer data
**Assumes one incoming/outgoing wire/month
***Money market balance * 1.25%

The bank would still charge per use fees for things like wires, ACH’s, overdrafts. And receive interchange income. But the spread should cover items presented plus profit for the bank. Imagine having 10,000 of the JFB’s Business Banker Account. Instead of 1,000 of this account, 2,000 of that account, 4,000 of another account, and 3,000 old grandfathered accounts. Which would be easier for your branch and business bankers to explain to your customers? And marketing people tell me that bankers sell what they know.

Does the JFB Business Banker account pass the Simple, Fair, and Transparent test?

~ Jeff

What will our depositors do when rates rise?

The subject has been on the minds of bankers for years now. The continued extension of the Fed's easing policy through possibly 2016 has given us a sense of security. But this pro-longed period of low rates, burgeoning core deposits, and uncertainty about what our depositors will do next should keep us restless.

For those that rely on yield for returns, it has been a tough time. Retirees, insurance companies, and bank treasurers have found it difficult to earn money in fixed income. Some have been able to squeeze gains out of bonds as rates fluctuated downward, but the second quarter flip from an unrealized gain to an unrealized loss in bank investment portfolios brought reality home to treasurers.

I'm not certain what depositors will do when rates rise. But I analyzed what they did the last time the Fed raised Fed Funds Rates in mid 2004. On June 30, 2004, the Fed raised the Fed Funds rate from 1% to 1.25%. Over the next two years, the Fed raised rates 16 more times, ending at 5.25% on June 29, 2006 (see chart).

The last Fed action prior to the 2004 rate rise was June 2003, when the Fed Funds Rate stood at 1%. Surprisingly, bank cost of deposits at that time was 1.43%. Note that all deposit and cost of deposit data was for quarterly periods, where Fed Funds rates were on the date they were raised. But once the Fed started moving rates up, bank cost of deposits lagged the movement upward. When the Fed ended its tightening in June 2006 at 5.25%, bank cost of deposits was 2.68%, a significant spread.

What did depositors do during this period? They moved money from core accounts (all deposit accounts less time deposits and brokered deposits) to non-core, as shown in the chart below.

But not to the extent one might think. Yes, non-core deposits as a percent of total deposits grew from 32% in June 2004 to 38% in June 2006. But core deposits did not decline during that period, growing 8.3% during the two year span. But time & brokered deposits grew 48.7% during the same period.

By the time the Fed stopped tightening in the second quarter of 2006, core deposits represented. 61.8% of total deposits. Today, core deposits stand at 77.8%. So, if past is prologue, then we can anticipate that although our overall core deposit base may not decline, time deposits are sure to increase. 

This analysis reviewed what happened to FDIC insured deposits across the U.S. How that money will flow between institutions is a result of efforts made by financial institutions today to win the loyalty of customers once rates begin to rise. Will they stay with you, or go across the street? Is it in your hands, or the hands of fate?

~ Jeff

How stable are your deposits?

I am attending the Financial Managers' Society (FMS) Forum in Las Vegas this week. The Forum is chock full of education opportunities for banking finance professionals. One session caught my attention. The tandem speakers taught the audience about going "long", or at least longer, in their investment portfolio and minimizing risk.

One of the underlying assumptions in advising to "go long" was that core deposits were as stable today as they were four years ago. I challenge that thinking. Average balances per account among most core deposit categories have been growing and I think customers are parking their money waiting for greener pastures. When they arrive, what will they do with that money? I put this question to Dallas Wells, an asset-liability specialist from Asset Management Group in Kansas City. I have followed Dallas' writings on his informative blog for a while now and caught up with him at the Forum. Here is what he had to say.

What do you think will happen to core deposits once rates rise?

~ Jeff

Community Financial Institutions: Parking Lot for the Benjamins

The current market volatility has been with us for nearly three years. To resuscitate the economy, the Fed is doing everything possible to keep interest rates low through monetary policy. First dropping the Fed Funds rate to near zero, and most recently with Operation Twist designed to guide long-term rates even lower. The Euro Zone debt crisis and resulting lack of investment alternatives makes US Treasuries, as one economist put it, the "best house in a bad neighborhood".

This has kept investment options for community financial institutions at historic lows. Low loan demand further exasperates the challenge.

While investment options dwindle, FIs find themselves awash in cash. Market volatility and prolonged low bond yields is keeping investors on the sidelines. The sidelines, as it turns out, is in banks. This led to Bank of New York Mellon's decision in August to begin charging very large depositors fees for parking their money. There simply isn't any place for them to lay it off.

Community FIs are experiencing similar activity from their Main Street customers. From December 31, 2009 through June 30, 2011, deposits for all FDIC insured depositories increased 5.84%. But average deposits per money market account, according to my firm's peer database, increased 31% during that same period (see chart). Community FI customers are parking their money waiting for better, more certain times.

At first, senior managers of FIs felt good about the inflow. Loans from 2002 through 2007 generally grew faster than FIs' ability to fund them. This resulted in FIs turning to CD rate promotions, brokered CDs, and FHLB borrowings to bridge the funding gap. Deposit mixes became more expensive and less attractive.

But with loan demand at historic lows, FIs began running off their high-cost CDs and other so-called "hot money" to right-size their funding sources. This may have created a little hubris among senior managements, thinking it was the quality of their service and the value of their brand that attracted the core funding. But looking from a wider lens shows us it has been an industry phenomenon more than what any institution did on their own.

This is creating uncertainty with Treasurers across the landscape. What does the FI do with the money? How long will the money remain in the FI before migrating back to the market or the hottest CD promotion? With historically low re-investment rates, FIs are keeping the money highly liquid. FDIC insurance costs, on average, are 12 basis points on deposit balances. This, and the operating costs for maintaining the accounts, is resulting in some core deposit accounts actually being unprofitable... a highly unusual situation.

But this too shall pass. If FIs are pleased at their current mix of funding, perhaps they should take positive action to maintain it. Initiatives could include a disciplined onboarding program for new customers, and a timely calling program for existing ones. Your customers may certainly be parking their money at your FI, but they probably have money elsewhere too. If you demonstrate service beyond what they experience at their other FIs, perhaps you can win their loyalty, including their core deposit balances.

Alternatively, you could do nothing, stuff your vaults full of cash, and pray that customers stick with you. Hey, it's possible, just not probable.

What do you suggest FIs do to keep core deposit customers?

~ Jeff

Note: I will be part of a panel discussion at the Financial Managers Society (FMS) Philadelphia Chapter on Wednesday, November 9th to discuss liquidity, value, and profitability of core deposits.