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PCBB Banc Investment Daily April 23, 2015
Banc Investment Daily
April 23, 2015

Looking To The Past To Build The Future

There has been a lot of justified happiness over the resurgence of the American auto manufacturing business. American manufacturers for some time have been dedicated almost exclusively to trucks and SUVs and yet Ford is making a bold step to re-enter the luxury car market on a level to compete with Lexus, BMW and Mercedes. Ford intends to bring back, of all things, the Lincoln Continental. The Continental last appeared in 2002 and was known as the car that carried US presidents in their official motorcades. Ford has also long been associated (at least in the US) with fleet vehicles like taxis and police cars. It turns out that the new version of the Continental is not geared for the US market, but rather towards the rapidly growing luxury car market in China. Chinese consumers do not carry the same brand associations, so by building a new vehicle with a new consumer in mind, Ford believes it can succeed with a highly profitable, high quality product.
If only banks could roll out something that did well in the past to a new group of appreciative customers and make a profit to boot. It is not getting any easier to manage funding and liquidity in this business cycle and driving customer behavior through product choices, as opposed to by interest rates, is particularly challenging. On one hand, it seems like short term interest rates may be about to rise, but there is also economic data that would suggest otherwise. Banks have to be prepared for either possibility and this creates a quandary for deposit committees. At the same time, regulators are asking banks to measure and assess their liquidity risk in a rapidly rising rate environment, with stresses beyond what seem reasonable given today's economy.
Deposit committees should regularly discuss not only rates on CDs and money market accounts, but bank products themselves. This discussion should include how products are presented to customers because deposit products do not act the same, nor do they have the same interest rate sensitivity characteristics.
Consider that if a bank is pricing along the national average curve, then one of the primary determinants of deposit costs will be its deposit mix. A bank with 20% of deposits in CDs should have a much different experience than a bank with 50% CDs, for example. It doesn't always work out that way though, because some banks price their checking, savings and MMDAs aggressively. This just turns those deposits into liquid CDs. Just because a product has a certain label does not necessarily mean it actually has the rate and sensitivity characteristics of that product type, so care must be taken.
Consider also that national average rates can be deceiving for certain deposit types, because few banks manage to attract longer-term CDs by pricing at the national average. To induce depositors to forego access to their money for multi-year periods, banks typically have to price near or above the rate caps. For that reason, banks that are cognizant of their funding and liquidity costs generally do not want much volume from these products and price them accordingly.
While banks are unlikely to be able to find a whole new market like Ford selling luxury cars abroad, bankers would be served well to make sure their deposit strategy makes sense alongside everything else in the bank. You have to consider policies, business models, local competitive issues, growth needs and overall goals to propel the bank to a prosperous future.