The Fed has signaled three rate cuts for 2024. Finally, funding cost relief is on its way.
Eventually deposit pressure will ease, but there will be more pain in the interim. Time deposits will rollover at higher coupons, MMDA rates will drift upward, and, most notably, the deposit mix will change from low cost deposits to rate-sensitive funds.
It’s a precarious position to be in. Market rates are starting to move lower, yet time deposit special rates have been relatively sticky given the importance of retaining upcoming maturities. There is a similar dynamic on the MMDA / High Yield Savings side as bankers’ posture to slow the shift in mix (according to DCG’s Deposits360°® analytics, there has been an 11 percentage point shift from non-maturity to time deposits through 12/31/23).
The Hidden Cost of Time Deposits
First, a look back on time deposit activity in 2023. Time deposit books grew by 45%. However, nearly half of that growth was a result of a shift from non-maturity deposits, which took a big bite out of the margin. Looking ahead in DCG’s Deposits360° client data, more than half of all time deposits are set to mature in the first half of this year. Additionally, our analytics are projecting less time deposit growth for 2024.
It feels like this year is more about time deposit retention and less about growth. The hidden, often, high cost of a time deposit special is the cannibalization of lower-costing funds. Cannibalization is inevitable; however, it’s critical to ensure it doesn’t spiral out of control.
The Multi-Million Dollar Question
So how do we fine tune our time deposit strategy for the following objectives:
High rollover retention
Low non-maturity deposit cannibalization
While lowering top offering rates
That’s like catching a genie in a bottle. Let’s explore some initiatives to help balance retention while protecting against cannibalization.
Push the Pricing Discussion: At the time of this publication, one-year wholesale market rates are approximately 5%. Although time deposit special offering rates have come down a little, the top of the market is still priced at or above wholesale levels. Special rates are generally priced at a discount to wholesale. Offering rates will move lower, it’s a matter of how fast you get there. Ask your team how far off the top of the market you need to price to just hold balances constant. The answer should not start with a five percent rate.
Expand Menu Offering: Develop an expanded product set that rewards deep-relationship depositors while chasing away hot money. Single-sourced time deposit relationships should be priced at a healthy discount relative to wholesale alternatives at this stage in the cycle. If we do experience cannibalization, let’s make sure we are paying the depositors who have more than a single relationship with the institution.
Close the Rate Gap: Assess the current MMDA / premium savings offering. Deposits360° data suggests that as the rate gap between liquid funds and time deposits narrows, so does cannibalization. This strategy requires precision to balance the reward of stickier deposits vs. rapid acceleration of interest expense. [Email Joe Kennerson to learn effective strategies for product rollouts.]
Be Quick to Pivot: Cannibalization will continue to take place. Track the data at least monthly to identify when it gets too expensive and be ready to pivot.
We seem to be nearing the backside of the most competitive deposit environment of our careers. Higher deposit costs and mix change will continue in the near term, but there are certainly basis points up for grabs given the impending Fed pivot.
Joe Kennerson is a Managing Director at Darling Consulting Group, developing custom balance sheet strategies with ALCOs throughout the country. DCG’s Deposits360° solution captures relationship-level data for financial institutions with a goal to track cannibalization, quantify the marginal cost of funds on deposit specials, forecast volume and rate expectations, and most importantly, develop effective deposit pricing and product strategies.
© 2024 Darling Consulting Group, Inc.
