There is a current trend afoot of refinancing certificate of deposit (CD) customer in order to take deposit customers away from sleeping banks and credit unions. While one bank’s “theft” is another bank’s competitive gain, both sides should be cognizant of the ramifications of this move. Some banks may let these customers freely go while others will combat the assault with higher rates, greater marketing or an improved structure. In this post, we explore both the math, the profitability, how best to play defense and how to use this tactic offensively.
In a rising rate environment, moving customers over quickly, before rates rise too much is important. If your bank is playing offense, the approach is to first go directly to your existing customers to see if they have CDs at other banks. Then you launch a direct and indirect advertising campaign via email, print, and digital that highlights your bank’s ability to potentially increase the returns generated off their CD holdings. This effort has the nice advantage of placing your bank in a leadership position that underscores your bank’s financial expertise and ability to act as a trusted financial advisor.
The call to action is an analysis of if and how much you can improve their return. Here, a landing page that collects basic information such as CD amount, rate, term and prepayment penalties works fantastic.
After collecting the information, you either make an online calculator or do it in a simple Excel model so you can display some derivation like the graphic below:
In the above example, we assumed a three-year CD with two years to go. In your marketing materials or sale presentation, you drive home the point that their current financial institution isn’t paying a market rate on the CD and by switching to your bank; they will make more money - In this case, almost $1,000 more.
Now that rates have risen, this tactic works nicely. It works particularly well for any bank that could not be bothered extending their early redemption penalties and still has them at three months (we used a six-month penalty above). The shorter the penalty is, the better. The longer the remaining maturity, the more rates rise and the more money they have, the more compelling the case for moving funds to your bank becomes.
Of course, you want to add all the necessary disclaimers and may want to show the after-tax effect, a longer time horizon (maybe include rollovers) or present the information in a different fashion.
Chances are, a material percentage, usually around 25% of the cases, will move to your bank. Your worst case is that you get turned down on the offer. However, you now have collected important information about not only their CD holdings but the extent of their banking relationships, their financial position, outlook, and their view on the economy. You have also positioned your bank as a financial leader.
The bottom line is, with potentially three more rate increases this year, now is an excellent time for this tactic if your bank is in need of more banking relationships and core deposits.
Why You Don’t Want To Do This
The biggest reason not to deploy this tactic is that while you can be effective at new customer acquisition, you are acquiring customers with a much lower average lifetime value compared to the average banking customer.
As can be seen below, where your average retail customer has a cumulative lifetime value of almost $6,000, a CD customer is significantly below that due to much lower annual profitability, shorter duration, greater interest rate/fee sensitivity and lower balances. A customer that is willing to move for rate is likely less profitable still.
In a strip of irony, acquiring banks are not only negatively selecting customers with lower profitability but are making them even less profitable by further training them to be more rate sensitive in the future. This is to say nothing of what this campaign might do to your employees as it teaches them that it is acceptable to market on rate.
This tactic may successfully acquire customers, but it may not be worth the effort and the risk of hurting both your existing customer base and your employee training. If your bank has a proven track record of bringing rate-sensitive customers over and converting them into servicing-loving customers than this tactic might be for you. However, for the average bank, this campaign can go wrong quickly, and you could end up with a less profitable bank in the future.
How To Defend Against This Tactic
If this tactic is used against your bank to steal your customers, you have a variety of options. First, you could obviously let those unprofitable customers walk and fight for the customers you want to keep. This is a workable strategy if you have carefully been constructing your brand, your culture, and your deposit base. If you have a low percentage of CDs and those CD holders that you do have are already at your bank because of service and reputation, then the offensive bank will likely be doing you a favor by removing close to 100% of your least profitable customers.
However, if you believe you are susceptible to this tactic, the first step is to increase your early redemption penalties to include the loss of a year’s worth of interest. Since the bulk of your CDs likely have maturities under two years, then a one-year penalty will at least make the tactic uneconomical for all but the fastest rate increases.
If your CDs tend to be longer (over 30 months) in nature, then the economics work quickly against you. In this case, you either have to proactively refinance the CDs yourself to something closer to a market rate, but below where you think your competition will offer a level, or increase the customer’s engagement with the bank.
Increasing engagement means a combination of selling them more relationship-based products to create more ties to the institution or working on your brand or service level.
One common way to do this is to segment your customer base and offer programs to match those segments. For example, some banks have offered a “community first” CD where the proceeds go back into the community to fund loan growth. Other banks have done, “woman first,” “minority first,” “jobs first” (a popular one these days) and even “industry first” CDs such as those targeted at non-profits, restaurant owners or manufacturers. Whatever you do, the goal is to train your customer (and employees) to manage something other than rate.
Putting This Into Action
As rates rise, expect more of this cannibalization tactic to occur by competing community banks, credit unions, and even non-banks. In the last two weeks, we have seen an increase in the two-year CD rate which is where all rate increases start. In the coming year, banks can expect a 0.50% to 1.00% increase in rates according to some forecasts. Not only will rates rise, but interest rate sensitivity will increase making deposits more negatively convexed. If you are on offense, the time to move is now before rates move further. If you are on defense, your time is almost up but moving now will at least mitigate some of the risk.
Submitted by Chris Nichols on March 30, 2017