Pulling in deposits: in competitive times, value proposition and execution counts
 
In recent years, core deposit gathering has been extremely competitive, especially so for community banks, which can’t necessarily resort to tactics like acquisition in order to grow. The fine art of making the balance sheet work won’t get any easier, either.
 
Threat of recession and the consumer-hailing habits of large and foreign-owned banks will make finding cheap and stable funding ever more a game for the stalwart and innovative.

Deposit growth—checking accounts, savings, money market funds, and CDs—has averaged from 5% to 6% in most markets annually since 2000 with a few dramatic blips up and down along the way, says Gordon J. Goetzmann, managing vice-president, First Manhattan Consulting Group, New York.  On average, the typical mid-sized bank relies on wholesale funding for 10% of its balance sheet assets.
 
Growth of core deposits is generally tied to rate of inflation, net new formation of households, and net business growth, Goetzmann points out,  making for regional variation.
 
Not all community banks are losers in their efforts to reach out to consumers and small businesses, as indicated in following regional scan:
 
• Bank deposits in Atlanta, spurred by population growth, flowed mostly into de novo and community banks in 2005, although a recent article in the Atlantic Business Chronicle pointed out that banks of all sizes were stepping up efforts to attract funds between 2006 and 2007.
 
• In Massachusetts, as reported in the Boston Globe in October 2007, Bank of America’s market share fell from 19.3% to 18.2%, and Citizens  Bank of Massachusetts and Sovereign Bank also experienced market share declines as consumers looked for a more personal touch.
 
• In Michigan, deposits grew just 1.3% in the year between June of 2006 and 2007 as reported in Business Review of Western Michigan. In that state, regional bank Huntington Bancshares, with 46 offices in 12 counties, was the second performer regionally, with $1.93 billion in deposits as compared to market share leader Fifth Third, which held $6.34 billion in deposits but has, at 117 offices, a much larger physical network.
 
Still, Anat Bird, formerly with Wells Fargo and founder of SCB Forums, San Francisco, thinks that regional and community banks fail to get a fair share. And yet attracting deposits will be a necessary activity, says Bird, who notes that commercial and industrial lending is still outpacing deposit growth in most places. “Deposit gathering,” she says, “will be the primary driver of earnings in 2008.”

Irrational pricing
The market for deposit pricing was especially turbulent in the early part of 2007 and has settled down since. Consultant Bird describes prices as steady “but not yet rational.”
 
Thomas Kohlmann, chairman, president, and CEO, of $1.4 billion assets Suffolk County National Bank, Riverhead, N.Y., agrees.
 
“The liquidity issue is part of the problem facing the industry,” Kohlmann  says. “The untenable rate-setting practices of some institutions are making things difficult,” he adds. He notes that his bank, despite its status as the second-largest independent commercial bank headquartered on Long Island, has only experienced a modest deposit growth in the last year.
 
Kohlmann explains that most of the deposit growth comes from business customers and that his bank has kept pace with recent service and technology changes, offering net deposit capture in recent months as one example.
 
Tied to that business niche, Suffolk County faces three distinct markets. The first is in the western end of Long Island, which is primarily industrial and commercial. The second is the South Fork of the East end, whose fortunes are linked to  bonus income earned by high-net-worth professionals from the New York financial markets. The third comprises the more agricultural communities of the North Fork.
 
A sometime borrower of the Federal Home Loan Bank, Suffolk County National, which has relied on its network of 27 offices to do business, is developing an internet site that it may launch as early as the end of the first quarter as a sort of low-key supplemental funds gathering mechanism.
 
“This isn’t anything that we will promote in a big way,” says Kohlmann. “Some that know us well would consider the internet project out of character, but it will be another source of picking up funds,” he notes, adding,“we don’t think of using the internet as a big shift in approach or values; it’s more like a tactical decision.”
 
Time for a new engine?
In the short-run, sub-prime reverberations are partially to blame for the current situation. Countrywide, for instance, had—prior to the acquisition  announcement by Bank of America—been trying to shore up its balance sheets by flooding cyberspace with comparatively high-rate offers. A few who spoke to ABA BJ described these actions with the phrase, “zombie mortgage lender,” referring to those who price CDs and other accounts at high—some think untenable—rates in an attempt to meet short-term objectives. (This was a variation on the term “zombie thrift,” of the S&L crises.)
 
Non-performing loans will also have the ambient effect of requiring community banks to put aside more cash in reserves, according to Alan Friesen, president and CEO, Haberfeld Associates, Lincoln Neb.
 
All in all, the consumer and small business deposit, typically taken for granted in most markets, has been moved to a top action item for the average bank CEO, notes Friesen.
 
“There are many ways to make money in banking—on fees, spread, and investments,” he says. “Recent events should force more bankers to really consider both sides of the balance sheet.”
 
At a recent gathering of dozens of community bank CEOs, however, Friesen relates that many, when quizzed by him, didn’t have ready knowledge of key stats such as their most, or least, profitable branch. Nor did any appear to have a working knowledge of profitable customers.
 
Friesen says that this is a time for thoughtful pricing, promotion, and—in general—for thinking more like retailers, measuring and managing profitability and other key benchmarks. He urged bankers in attendance to get a good handle on opportunities for additional product sales among their existing customer base.
 
“Most community bank CEOs grew up in the loan side of the business and they still tend to think of the loans as the engine of profits,” says the consultant. “This period will have many rethinking basic assumptions.”
 
Certainly, looking hard at demographic data can help.
 
Michael Quick, executive vice-president and group executive, Susquehanna Bank DV (which stands for Delaware Valley), Camden, N.J., part of $12-billion assets Susquehanna Bancshares, based in Lititz, Pa., says that his bank has felt the heat of recent competition when it comes to growing deposits. However, it managed to stay in the kitchen, so to speak, by “executing the basics of service consistently,” says Quick.
 
The senior executive acknowledges a new set of defining dynamics evident in this cycle of relatively scarce cheap funds. “With the eTrades and Merrills and INGs out there, it can be hard for smaller institutions, even diversified ones, to hold onto business,” he admits.
 
Still, Quick believes that doing well by the customer  can lead to profitable referral business, which helped his bank grow deposits by 2% last year.
 
“Word of mouth has always helped me in this business and I’m teaching our people how to make referrals work for them and support some organic growth for us,” says Quick. “In our training, we emphasize relationship selling and the importance of generating leads through happy customers.”
 
Also key for the bank holding company in general has been the understanding of product requirements for a mix of clients throughout its four-state footprint of West Virginia, southern New Jersey, central Pennsylvania, and Maryland.
 
“Central Pennsylvania, for instance, is largely a retirement community with fixed income folks that are concerned about asset preservation and income,” says Quick. “Other markets rely more on a mix of working professionals and small businesses.”
 
This year, the bank used segmentation analysis to leverage segment distinctions  in offer messaging and products emphasized, picking up $270 million in additional deposits over two mailings alone.
 
The bank’s third direct mail campaign, which was in the planning stages as of this writing, was to be aimed at a mix of customers (15%) and prospects, some of which were identified through referrals. 

Why deposits ebb—and flow
Other conditions-of-the-moment include the perception of recession, a creeping personal cost-of-living index, and stock market volatility—some of which might nibble at deposits, some of which could go in the industry’s favor, notes Greg McBride, senior financial analyst, Bankrate.com.
 
“In a recession, consumers tend to remember the value of money and care more about having an emergency fund,” he explains. “Certainly, bank customers with the means to play in the market will pull back if there is a sudden drop in return.”
 
This pullback into safety, after all, was one driver of bank profitability after 2001. “The only thing that might work in the industry’s favor is the consumer quest for a safe haven if the stock market gets super volatile again,” agrees William J. McGuire, president and CEO, Scottsdale-Ariz.-based McGuire Performance Solutions.
 
But Terry S. Key, president and CEO, Lubbock National Bank, in Lubbock, Tex., questions the value of such gains. “Customers aren’t loyal anymore,” he says. When asked why consumers seemed more rate conscious and prone to switch over business, Key answered: “The time has passed since members of a community felt their bank could make or break them. The perception among many business people and consumers is that they don’t need our acumen. Any source of funding will do and anyone can price a loan or offer bank services.” Key says that performance chasers make the business tougher for everyone. To cope, the $488 million assets Lubbock National has offered internet CDs through National CD Rateline, limiting amounts raised to $95,000, “so it counts as core deposits.”
 
Meanwhile, experts say, there are also steady-state factors affecting competition for deposits for the foreseeable future.
 
“The internet has empowered the consumer to rate shop and served as a venue for all sorts of bank offers. The environment is consumer and business friendly. It can pull deposits out of a given region,” says Greg McBride. “And, I would argue, it’s made everyone more price sensitive.”
 
Anat Bird agrees. With internet-only banks currently taking about 10% of deposits off the table (other experts disagreed with her estimates, saying the figure was far lower at present, but admitting  that it could grow rapidly in short order), and that share likely growing into the future, community banks will have to be creative to get their fair share of deposits going forward.
 
“Community bank management has been too nice in the past,” says Bird. “The leadership will need to push their frontline people to follow through and they need to find ways to parlay their community involvement into business.”
 
Mike Carlino, president and CEO, Cambridge Bank, Lake Zurich, Ill., says his bank has made use of the Qwickrate internet service to manage liquidity. The $400 million assets institution has hung in despite Chicago’s ruthless branching development by having a classic, service-oriented focus that includes small businesses. “Chicago’s always been a tough town,” he says. “That’s why it’s important to zero in on very specific opportunities here.”
 
Indeed that other real estate matter—the branch build out—which was an extensive, some say, extravagant, feature in most regions of the country between 2002 and 2006 now puts pressure on all core deposit gatherers.
 
“The average U.S. branch is only at a third of its capacity,” says Friesen. “At a time when we have three times as many branches as we need to support the population, it’s pretty clear that everyone is on the hunt for customers and new sales opportunities.”
 
William McGuire agrees it’s been a market of scarce funding and it will hit smaller institutions hard. “It’s tough for community banks. On the lending side, the loans have leaner margins, yet there is a lag and banks are forced to pay more to consumers for deposits.”
 
Not everyone thinks the current cycle was especially troublesome. “The need for deposits is currently outpacing supply in many markets, but it’s cyclical and not especially pronounced or problematic,” says Bob Wiseman, president, Agiletics, a Longwood, Fla.-based firm that teaches banks how to reduce deposit gathering expense as well as an expert in non-volatile funding such as escrow accounts.

What’s different now?
Whether you believe this scarce funds cycle is like any other or a doozy to be reckoned with, there are other considerations. Gordon Goetzmann points out that a complicating factor in the deposit-gathering game is the fact that many banks are offering what’s viewed as a commodity.
 
“Eventually, somebody will figure out how to move beyond free checking, which nearly everyone has already copied,” says Goetzmann.
 
After all, says Goetzmann, it was free checking as an innovation that allowed a bank such as Washington Mutual to five years ago push into Manhattan, a notoriously hard-nosed place to pick up customers.
 
“Differentiation—and solid execution against that value proposition—is what gets customers to switch banks and stay,” he says.
 
Tom Farin, president and CEO, Farin Associates, Fitchburg, Wis., believes that in the future banks will need to rely on non-CD products with a palette of interesting features.
 
“Generation X and Y doesn’t understand or gravitate toward CDs the way previous generations did,” he says.
 
“And in the short run, we advise our clients not to chase the hot money. We tell clients that can go to the Home Loan Banks or other wholesale sources to do so, because it will be cheaper, at a current rate of 3.95% than having to pay 4.50% or 4.75%,” Farin adds.
 
Beyond current rate fluctuations, banks will need to evaluate customer segments and price accordingly, setting up rules that reward customers with basis points if they keep balances, for instance.
 
“In an ideal world, you’d price each retail deal one at a time, like you do with business accounts,” says Farin.“While the volume of retail customers makes it impractical to work this way, definitely reward your most valuable customers as part of an overall deposit retention strategy.”
 
The consultant advises banks to look at holes in their product set and devise offerings that fill those gaps to reach a new segment of the market or sell more to existing customers.
 
“Set up, for instance, a rewards checking account that has a minimum debit transaction requirement,” says Farin.  “You’ll pull in some interchange as a way to shave off some of the expense.”

Retention counts
Not everyone agrees that such rules-based accounts can do all that much for banks, but nearly all the sources who spoke with ABA BJ agreed that as a general rule, banks need to think about the basics of execution and communicate to the market how they add value to attract and retain clients.
 
Gwenn Bezard, an analyst at Aite Group, Boston, issued a report this summer called Why Money Can’t Buy Love, which studied how the best performers went about growing deposits, based on Harland Financial Solutions Benchmarking Database.
 
“The most effective achieved deposit growth through retention and cross selling an existing customer base,” says Bezard.
 
In this case, the numbers gleaned from transactional data supported conventional wisdom touted for the last decade: It’s costly to replace today’s customers with tomorrow’s, so leverage relationship. BJ

The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0208/index.php?startid=38

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