Deposits: The Next Banking Refinance Boom

As depositors consider economic risks, and as significant Federal Reserve rate increases lure treasury managers to assess their returns, financial institutions must engage depositors with information and options, if they wish to fend off deposits pricing pressures that threaten profitability.

Current data indicates that financial institutions still hold high volumes of retail deposits at ultra-low interest rates, significant portions of which have months or even years to mature. For years, many conventional-thinking banking executives have felt burdened by excess deposits. The landscape, though, is shifting such that a single-minded focus on minimizing the cost of funds will produce sub-optimal financial results.

High-performing financial institutions, on the other hand, will create more significant profit through a combination of volume and spread. In fact, banks and credit unions can lock in as much as $2.25 million in riskless profits for every $50 million in deposits retained; and they can do it while serving customers well without price-matching competitors.

Either way, urgency soon will build for leaders to orchestrate aggressive deposit retention strategies as competition ramps up for depositors’ business. Early withdrawal penalties now are – almost universally – not enough to render refinancing unprofitable for deposit holders. Many bankers report that public fund treasurers are already running the numbers to close out old contracts, take their penalties, and reinvest at today’s higher interest rates. We can confidently predict that retail depositors will soon be open to such opportunities as well.

A new view, rethinking penalties

Even as simple as the math is, many institution leaders did not take the time to stress-test their portfolios for the consequences of refinancing CDs in a rising-rate environment. The costs could be significant. Just as fintechs took low mortgage rates as their entry into real estate lending, others that focus on banking now will use rising rates as their entry into consumer banking, and even into larger treasury relationships.

Leaders have an opportunity to look at deposits from the eyes of depositors and to redesign the experience so consumers can get more of what they want and add profit to the financial institution in the process.

Static penalties should be considered first. They produce little if any revenue and fail to provide an effective barrier against early withdrawal when coming out of a low-rate environment. For example, take a depositor who owns a certificate of deposits with a five-year term paying 0.8%. If, after 12 months, the interest rates available on a three-year U.S. Treasury are over 3%, they can gain from cashing in the original term deposit, paying the penalty, and reinvesting at the higher rate. The penalty is a nuisance that contributes to lost relationships more than it prevents deposit runoff. 

Equipped with data on break points in the deposit portfolio where interest rate risk is not adequately protected by penalties, banking leaders can begin looking at deposit products from the other direction. Knowing what benefits their institution, they can define products that most benefit the depositor. Customers or members who would benefit from new deposit options then become candidates for a call from banking personnel, for a lead generation campaign, or for engagement through intelligent automation for depositors.

When others play on price

Remember pricing deposits in 2017-2019?  If leaders don’t want to participate in a deposit price war, then engaging depositors now with education and options is imperative. While others float toward price competition, strategic institutions will design and engage depositors in the most pertinent ways to their financial situation.

For example, depositors want to exit time deposits now because rates appear to offer opportunity. But, since no one knows what rates will do, that desired liquidity can have a retention effect. Just as uncertainty about rates affects the value of banking assets, future rate movement also affects the value of depositors’ assets: CDs and savings accounts. In times of rate uncertainty, liquidity has increased value to consumers who want CD yields, because they are also worried about locking a rate in.

But institutions can’t simultaneously provide liquidity and an attractive yield, right? Wrong!

We see institutions offer a hybrid deposit arrangement—a CD combined with a high-yield savings account—in situations where depositors request more value. They offer a high-yield savings account with a CD rate, but only when the depositor has committed to the financial institution with a term deposit. The depositor now has a sweeter deal than what term deposits offer on their own—access to a CD rate with the liquidity of a savings account.

Where before the institution was fighting to keep a CD, it might now gain the entire deposit relationship because it offered both rate risk management and yield. While not every depositor will qualify depending upon the size of the penalty and the amount of time to maturity, those who do are most likely to add deposits at a price properly fitted to the institution’s asset-liability strategy. In that case, the depositors get more than they asked for. 

The first wave of banks that launched this approach during the last deposit refinance boom saw double-digit percentage growth in properly priced, long-term retail deposits. Let’s dig into the results for the institution.


U.S. Treasury rates dwarf CD offerings

High-wealth depositors consider U.S. Treasury yields alongside certificates of deposit when assessing where to safely invest their money. Yet, when you look at bank and credit union offerings for time deposits in the second quarter of 2022, the median time deposit portfolio yield was only 0.66%, and the trimmed average was 0.69%. Only the top 5% of institutions had portfolio rates above 1.33%.

Meanwhile, U.S. Treasury yields are now at 2.65% for 6 months, and 3.26% for a year.

The math is there today for depositors to pay penalties and leave with their deposits. Paying a modest fee to go from less than 1% to more than 3% is a slam dunk.

Institutions need to equip staff with a playbook for this scenario as soon as possible. Otherwise, losses could be worse than just the sum of departed deposits. No leader wants to look back and see that they sat passively by missing both an opportunity to control the cost of funds and to establish the organization as depositors’ preferred financial institution.

Better to create relationships today than go to deposit markets, hat in hand, in 12-24 months to buy back those very deposits.

Value from relationships, not transactions 

In the mortgage world, refinances are transactions. The borrower wants a rate, and the lender wants an origination. Depositors and financial institutions can also treat what could be a relationship as a transaction. Those institutions that show real effort to help people’s finances, though, can win hearts and minds among consumers. And, if they know their data and portfolio, they can do it while also positively impacting their margins.  

Consider the financial gain that can be achieved by a financial institution that refinances $50 million of 3-year deposits today with a 150-basis point spread below U.S. Treasuries at 1.50% APY. Locking in this spread for that term and amount creates $2.25 million of riskless profits. Every dollar refinanced at this spread creates only more value for the financial institution. 

The deposit refinance boom also has deep meaning for institutions’ financial relationships. For more than 15 years, people with the most wealth, such as retirees, have been forced to either seek returns from stocks—a very high-risk investment for retirement—or accept the historic-low returns of safer investments like CDs. Now, another generational cohort is reaching retirement age. Both those in the Greatest Generation and Baby Boomers await safe returns they can live on. These are also the most likely consumers to have capital in quantities most attractive for banks and credit unions.

Now, institutions must show that they understand and want to help with education and options. For many years, CDs and high-yield savings have been seen as “dinosaur” products. But few would make the same analogy about the enormous cohort of depositors who soon will desire valuable deposit offerings. What’s more, great grandma, and grandpa and grandma, see CDs as a staple of the banking offering.

In addition to leading The CorePoint, Neil Stanley serves on the board of TS Banking Group, which operates bank charters in Iowa, North Dakota, Illinois, and Wisconsin. He also leads the idea exchange for banking executives in the Sheshunoff CEO Affiliation program.