A synopsis of a presentation given by Curinos Directors Brad Resnick and Adam Purvis at the GFMI Retail Deposit Optimization and Strategic Management event in New York on June 21, 2023.
Today’s Market And Key Industry Trends
The Fed Overnight Rate is expected to hold at its highest level since 2007 or rise slightly as inflation remains elevated.
The number of times the Federal Reserve has raised its overnight rate since June ’22 and the speed of the cadence have been almost without historic precedent. The current rate target is 5.00% to 5.25% and, despite a recent pause, is expected to rise again this year, defying earlier estimates that it may fall. Meanwhile, the yield curve remains highly inverted, with the two-year yield on Treasuries eclipsing the 10-year yield by almost a full percentage point. This indicates that investors seeking low-risk yield anticipate elevated short-term rates to persist. “Higher for longer” continues to be the watchword. (See Figure 1.)
The balance surge of 2020 to 2021 is eroding quickly, forcing many banks and credit unions to protect their funding base.
Stay-at-home behavior fueled by government subsidies created an outsized surge in deposit balances during the pandemic. The return to normal and the unanticipated emergence of inflation that followed spurred and then sustained a reversal. What had been a surge is now eroding, and many banks and credit unions are scrambling to protect their base. Since Q3 ’22, interest rates have spiked. From near-zero as recently as last summer, average acquisition rates have climbed to 3.11% and average portfolio rates now stand at 0.90%. Much of the spike has been driven by a remixing of savings balances to term products, notably CDs. (See Figure 2.)
Branch deposit runoff in 2022 was driven by inflation spending and, later in the year, rate-based churn.
Almost two-thirds of the branch deposit runoff of $487 billion was attributed to spending spurred in part by pent-up demand but mostly because of inflation. Churn to direct banks accounted for just under 20% of the runoff, or $96 billion, while the purchase of I-bonds and the slowing growth of deposits year over year accounted for the remaining ~19%. (See Figure 3.) Thus far in 2023, direct banks are gaining deposits week over week by from more than 1% to 3.5%. Other providers, on the other hand, are essentially flatlining – giving up as much as they gain from week to week. (See Figure 4.)
Figure 3: Projected Key Drivers of Branch Deposit Runoff | Jan ’22 – Dec ’22
Figure 4: Average Weekly Consumer Deposit Growth By Bank Type (% of Previous Week Balance)
The March bank failures affected deposit outflows, particularly in wealth and commercial, but consumer deposits have held up.
In large measure because most of them are insured, consumer deposits remained stable in the wake of high-profile bank failures in March. Wealth deposits, on the other hand, three-quarters of which were uninsured in mid-March, displayed significant runoffs and volatility, as did commercial deposits. (See Figure 5.) A material portion of both wealth and commercial deposits left the banking system altogether in search of higher rate through money market funds (MMF). In total, more than $600 billion flowed from financial institutions between March 10 and June 13, a gain of 12% in both retail and institutional MMFs. (See Figure 6.)
Figure 5: Average Weekly Deposit Growth By LOB (% of Previous Week Balance)
Figure 6: MMF Flows
Some banks priced up and grew, while others took low beta and shrank, but the median indicated net outflows for the industry.
In the year following January ’22, only the top quartile of banks posted deposit gains, and they were a relatively anemic +2.6%. The bottom quartile lost more than 12% of its deposits. Pricing diverged significantly. The average beta (the difference between what banks charge for deposits and the Fed Funds rate) for the top quartile was 3.3% while the bottom quartile exhibited an average beta of more than seven times that, at nearly 22%. But no matter what the strategy, the banking category on average lost deposits for the one-year period, with consumer outflows estimated to be $800 billion. (See Figure 7.)
Figure 7: CONSUMER DEPOSIT GROWTH
All products, Jan ‘22 – Jan ‘23
CONSUMER PORTFOLIO BETA
All products, through the cycle to Jan ‘23
The shortening of the weighted average life of deposits indicates that the long-term stability of deposits has waned.
A key gauge of deposit stability is how long those deposits stay on the books, as measured by the weighted average life of deposits, or WAL, a trailing indicator. In just over a year, from December ’21 to January ’23, WAL of retail savings and checking declined by almost half, from a range of eight to nine years to only four to five years. WAL for business accounts was directionally the same but not as pronounced. (See Figure 8.) The implication is that money is on the move. Both consumers and businesses are shopping for ways to make their deposits work harder.
Figure 8: 12M Trailing WAL vs. Fed Funds Target
Deposit growth is likely to remain below average in 2023 and 2024 and not get back to historic normal until 2025 or 2026. Until then, expect even more competition.
High inflation, the Fed’s quantitative tightening and alternative products and providers will continue to put a drag on deposit growth for the balance of this year. Backed by positive growth to GDP, next year will show limited growth, but the market will likely not show material growth until 2025 at the earliest. Online banks will continue to put rate pressure on traditional providers this year, but a falling rate environment is likely to lessen some of the competitive pressure in 2024. (See Figure 9.)
Figure 9: Curinos 2023 & 2024 Consumer Deposit Forecast
There are important implications for weak balance growth and/or a high-rate plateau.
In an environment where high rates may plateau and deposit balances slow, how can traditional providers respond? Here’s a guide.
Potential Trend in a 2023-24 Falling Rate Cycle
Continued inflation-driven runoff in ‘23 leads to slower or negative growth
Weak growth could intensify competition for balances, leading to higher betas
Rates remain high and plateau for a longer period than expected, extending into ‘24
Rates remaining high for an extended period could lead to decreased balance movement in the market
After sustaining high portfolio rates through ’22 and ’23, banks drop rates aggressively to cut back on costs
Aggressively dropping rates could lead to greater levels of switch and attrition
Source: Curinos Analysis
Precision Pricing And Analytics
Elasticity, which measures deposit demand as a function of a bank’s pricing position relative to competition, is at the foundation of a pricing strategy.
If pricing doesn’t rise to meet demand, some deposits will attrite and the ability to acquire new accounts will evaporate. Conversely, if pricing stays with demand, there’s opportunities to pick up balances, most likely from price-sensitive segments. The middle ground is the area of indifference or “no man’s land.” (See Figure 10.)
Figure 10: Elasticity Methodology: Typical Price Elasticity of Demand
Unlike previous rate cycles, this current area has grown to be over 300 bp, which is massive compared to previous rate cycles. Without knowledge of the price-response relationship, financial institutions can be exposed to typical pricing pitfalls, such as:
- Reacting too quickly to perceived actions of competitors
- Not recognizing differences in products, segments, and regions
- Failing to reinforce desired pricing activity and behaviors at the front line
- Focusing only on acquiring balances, not full balance flows and repricing risk
The unusually wide area of indifference (no man’s land) has been caused by the current unprecedented spread between front book and the back book rates, which will lead to repricing.
As recently as a year ago, mid-2022, all rates – portfolio, standard, blended-acquisition and promotional – were highly compressed. Today, they are notably divergent, and even more than the last rate cycle peak in 2019. (See Figure 11.)
Figure 11: Savings/MMDA Rates
A consequence of rate divergence has been the significant migration from savings and checking to term products, notably CDs.
As recently as April ’22, annualized balances moving to term products was almost nonexistent. A year later, the shift from savings and money market accounts (MMA) to term was hovering close to 10%. (See Figure 12.) This cannibalization has sharply increased the true cost of acquiring balances, as measured and tracked by the marginal cost of funds (mCOF). In 2020 and 2021, the cost of acquiring balances was very close to the rate paid. Beginning in 2022, however, those metrics diverged, with recent months displaying an mCOF of a whopping 10+% versus a rate paid of 4%.
Figure 12: Annualized Switch to Term
Percent of Existing Portfolio
Incorporating price response modeling at the flow level allows for the full picture of both new-to-bank money and retention flows.
In the balance waterfall showing modeled flows, acquisition balances are the most elastic while existing balances are far less elastic. (See Figure 13.) While these relative levels of elasticity are known, without implementing and back-book models in tandem with the acquisition models, financial institutions will be unable to balance the new-to-bank dollars with the repricing exposure of the existing balances.
Figure 13: Balance Waterfall with Modeled Flows
Customer-level pricing needs to start with segmentation based on behavioral characteristics, including rate sensitivity.
Effectively managing deposit pricing means being surgical. Otherwise, wide swaths of the back book can reprice, saddling the institution with an often huge expense that’s entirely avoidable.
Being surgical means segmenting the depositor base by their behaviors. Curinos has identified these four distinct segments, each of which displays attitudes and behaviors toward saving that are both materially different from one another and actionable:
- Chronic Shoppers: These people are rate-driven and move balances when a promotional rate expires. They’re fast to come and fast to go.
- Situational Shoppers: These savers shop when they come into enough money to prompt them to seek rate, from sources such as bonuses, tax refunds and windfalls.
- Engaged Savers: These depositors maintain stable or growing balances tied to a deep and engaged relationship with the institution.
- Unengaged Savers: Even though their relationship with the institution tends to be shallow, these savers maintain stable balances.
Because of their deep, engaged relationship with their institution, Engaged Savers, for example, display a history of renewing even when the rate offered is below the maximum. In fact, they’re likely to stick around and even grow their balances when rates are well below what they could receive elsewhere. Chronic Shoppers, on the other hand, display no history of renewal. Because their relationship with their institution is shallow or virtually nonexistent, they’ll jump at the next attractive market rate. If a provider is looking to retain their balances, it will need to offer a premium rate.
While two customers could be in the same pricing cell on a standard rate sheet, customer-level segmentation allows for different treatments of these two illustrative customers. Previously, the financial institution had no choice but to offer the customer the same rate, thereby over-pricing Customer 1 to retain Customer 2. With customer-level treatments, on the other hand, the financial institution can offer a rate premium to the Chronic Shopper while offering a below-market rate to the Engaged Saver (See Figure 14.)
CUSTOMER 1: ENGAGED SAVERS
CUSTOMER 2: CHRONIC SHOPPERS
History of Renewal
History of Renewal
Deep, Engaged Customer Relationship
Shallow or Nonexistent Customer Relationship
Likely to Renew Even at Sub-Maximum Market Rate
Moves Balances if Higher Rate is Observed
Growing and Stable Balances
Fast to Come, Fast to Go
Customers with stable balances who are tied to a strong relationship with the bank are likely to stay.
Offering a rate premium to rate-driven customers helps to retain balances from this customer segment.
Source(s): Curinos Analysis
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