It seems like something is getting lost in the tribal knowledge of deposit gathering. Certificate of deposit (CD) “specials” and the odd-month CD offering are a good example of this. As the legacy knowledge of deposit gathering is passed down from generation to generation of banker, some of the finer points of liability structuring are getting bastardized with some knowledge just plain forgotten about. In this article, we highlight how many banks are misusing CDs at the detriment of their balance sheet plus offer some recommendations.
Going Back In History
With loans booming and deposit growth hard to come in the 1950’s, it was Hall of Fame Banker Walter Wriston, then an EVP of First National City Bank of New York (later renamed Citibank), that drew frustrated that he had no tools other than a savings account to attract new money to the bank. At the time, as rates went up, corporations and wealthy depositors would take their money out of banks and put them in Treasuries.
By 1961, Walter had received the necessary regulatory approvals and found the perfect test case with a commercial customer that was threatening to leave the bank. Walt was able to pay an attractive rate in exchange for the customer agreeing to leave their money at the bank for a contractual amount of time. The CD market was born.
By 1966, there was $15B of CDs issued by banks, a market that was second only to Treasuries. Then, it was common practice to publish your “on-the-run” CD rates but not publish your “special” rates. As Wriston used to admonish his executive team, the rates on “specials” were never to be published as you never wanted to upset your existing customers that were not getting that rate or cannibalize your current deposit base. Specials were kept quite and were only the domain of EVPs and CEOs that had the authority to grant them for customers that you either want to reward because they could bring over business to the bank or that were already rate sensitive and you wanted to retain.
Fast forward to the 1990’s when the “odd month” CD became popular. Instead of issuing a 12-month and a 24-month CD, bankers often issued a 13, 15, 18, and 26-month CD in the place of the on-the-run traditional CDs. The concept was that depositors wouldn’t care much between 12 and say, 13 or 15 months of maturity and would treat these maturities all the same. As a result, you could offer the same rate while picking up a couple of months of maturity and duration in the process.
Over time, it became common practice to make your special CD offerings maturing in odd months. These specials, also called the “off-the-run” CDs, were not published but became more standardized with authority to issue these specials given to the branch and assistant branch manager. When that was done, specials became more widespread and were used for almost any customer that threatened to leave, regardless of profitability. In addition, these off-the-run CDs were also pitched to almost any new prospect.
Around the same time, smart bankers started to use the off-the-runs as an asset-liability tool to save money and “buy” a little extra duration. Bankers would pay a couple of basis points higher than their 12-month CD offering for their special, non-published 15-month CD. The rate would be lower than the linear interpolated rate between the 12-month CD and the 24-month CD. In this manner, bankers limited the impact of these “specials” while customers were happy because they were getting more interest than a 12-month CD offering.
Somewhere around 2004, we lost track of history and bankers started to mix concepts forgetting the purpose of both specials and odd-month CDs. In today’s market, for example, banks publish a 12-month and 13-month CD right next to each other allowing for easy comparison. Worse yet, many banks publish their specials, often right next to their on-the-run offerings (below) thereby not only training customers to be rate sensitive but obliterating their on-the-run offerings causing both customer (and employee) confusion and increasing operational cost.
Very few customers would choose any other maturity other than a special due to the significant rate difference.
The Better Way To Use Off-The-Run CDs and Specials
Banks need to get back to their roots. While any time you market on rate, you have failed to properly convince the customer of your value proposition, sometimes you have no choice. Here are some best practice tips culled from some of the best CD managers in the country.
Reduce Your CD offerings: We went in-depth about this in a previous article (HERE), but one way to boost liability performance is to get rid of all your on-the-run CDs and just offer odd-month CDs the way Citizens Bank does it (below). This focuses deposit marketing on checking, savings and money market accounts, three areas that hold the most value for a bank while allowing a limited number of options for maturity-focused accounts. The odd-month CDs limit the comparison to other banks further helping to bring in the less interest-rate-sensitive customer.
If you are intent on keeping a full run of CD maturities, at least create gaps in your offering, so you limit competition with yourself. If you are going to publish a 14-month, odd-month CD, then do away with the 12-month and 18-month CD.
The customer’s time is valuable; you would rather be discussing other bank solutions than taking time explaining if a 1.00% 12-month CD is better than a 1.02% 14-month CD. Unfortunately, it is common for a bank to have ten or more published on-the-run CD offerings, five specials, five callable CDs, each with three tiers plus a “Bump” and “Add-on feature.” That’s 20 CDs with 100 variations. Do you really want to take all that cognitive time for one of the least profitable products in banking?
Keep Specials Special: Specials should be, well special. The minute you publish specials they just become CD promotions and you just set a new floor for CD pricing. High rate promotions train both employees and customers something that only takes days to do, but years to undo. Limit your use of specials when you absolutely have to have rate as a weapon and keep your employees and deposit base focused on your core value proposition – service.
As rates continue to rise, deposit beta will continue to increase. As it does, look for CDs to become more competitive. The national average rate for a five-year CD is at 2.80%, a level that is almost to the point of breakeven (2.88%). Soon, competition will jump pricing for one-year and two-year CDs bringing them to also to the point of a breakeven pricing proposition. As rates and beta increase, mistakes in deposit structuring and pricing become more costly. Watching how you use odd-month and special CDs is an easy solution in protecting your balance sheet and an easy way to follow in Walter Wriston’s footsteps.
Submitted by Chris Nichols on August 13, 2018