The day will likely come when interest rates rise and banks must boost payouts on certificates of deposit to keep pace with competitors.
The question then becomes, how far will they go to prevent their best customers from leaving as they hunt for the highest CD rates? It's a dilemma that all bankers face and it's one they've had plenty of time to ponder, as CD rates have been stagnant for years.
Some bankers say they have little wiggle room if they want to retain customers.
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The Federal Reserve has made clear that higher rates are more a question of when, not if, but banks should let go of rate hikes being anything like they were under Alan Greenspan.
June 6 -
Key Democrats abruptly reversed course Tuesday concerning a monetary policy tool, saying they now support the Federal Reserve's ability to pay interest on banks' excess reserves.
May 17
"Rates have been low for so long, there's not much else we can do except raise rates" if the Federal Reserve approves rate hikes, said Dale Keasling, chairman and chief executive at the $2.2 billion-asset Home Federal Bank of Tennessee in Knoxville.
Others say they don't need to raise rates across the board to retain their best customers.
The $9 billion-asset Cadence Bank in Houston, for example, will occasionally offer promotional CDs to its "more rate-sensitive customers," said Chief Financial Officer Valerie Toalson.
The average rate on a 12-month CD at about 50 of the largest banks has remained below 0.5% since September 2011, according to Ken Zerbe, an analyst at Morgan Stanley. The average rate for a 36-month CD has remained below 1% during the same period.
Though last week's job's report tamped down expectations that interest rates would rise this month, it is still very likely that the Fed will move to raise rates later this year. And if and when it does, CD rates nationwide will probably follow suit, Zerbe said.
Banks, by and large, will welcome a rate hike or two, but the downside will be higher funding costs. Those costs should eventually be offset by higher loan yields, but there will be a lag time because banks can't immediately start repricing loans.
Thus, in the short term, many banks could be stuck in a kind of no man's land. They need to keep and gather deposits, but they can't get desperate, said Jim Sandgren, president and chief operating officer at the $11.8 billion-asset Old National Bancorp in Evansville, Ind.
"We're not going to be a 'hot-money' bank," Sandgren said. "As rates rise, we have to keep a close eye on the competition and try to keep some of that money. But those folks who are very rate-sensitive, those are not our relationship-driven customers."
At the same time, banks must do something to retain their highly coveted clients, said Neil Stanley, chief executive at the CorePoint, a bank consulting firm in Omaha, Neb. It takes creative thinking to keep those customers from walking out the door and taking their deposits with them, he said.
One tactic is to offer the most coveted customers a product that pays a rate above that of a traditional savings account but not quite as high as a market-rate CD. It acts more like a savings account in that it carries few restrictions on withdrawals, Stanley said.
"This is ideal at financial institutions where management would like to lower their cost of funds, while retaining greater volumes of low-cost funds," Stanley said.
For banks that don't plan offer a customizable savings-account product, as Stanley suggests, it's a matter of figuring out the right timing for raising rates, said Home Federal's Keasling.
"There's a real fine line there, because we can't raise our investment yields and loan yields at the same time we raise deposit rates," Keasling said. "It's something we will have to do over a period of time."
It's also a tricky proposition because deposit costs have already started rising over the past year. Total deposit costs for all U.S. banks in the first quarter rose 7.4%, from a year ago, to nearly $7.9 billion, according to BankRegData.com, a data provider in Dallas.
How banks respond to rising funding costs will vary widely, because rates are already all over the map. Wells Fargo's 12-month CD rate was 0.05%, as of May 31, according to Morgan Stanley. That's one of the lowest rates among the largest banks.
On the other end of the spectrum, the $12.4 billion-asset Third Federal Savings & Loan of Cleveland recorded about $10.3 million of interest expense in the first quarter on time deposits of at least $100,000. That represented about 2% of its total net interest expense, the highest rate of the 100 biggest banks that maintain retail branches, according to BankRegData.com. Third Fed pays 0.3% on a 12-month CD, according to its website. That's six times higher than Wells Fargo.
Banks like Third Fed that have a higher percentage of their deposit mix tied to CDs, could see a bigger reduction in their funding costs as their CDs reprice at lower rates, or simply run off, Zerbe said.
Then there are the FoMO customers who constantly suffer from a "fear of missing out," namely the next rate hike. Banks need a savings-account product where these customers can park funds and earn some interest while gauging the Fed's intentions, but still be able to withdraw at any time to take advantage of a rate hike, said Stanley, who advises bank clients how to implement such product offerings.
That type of customer may be the most difficult to satisfy, Keasling said. During the early 1980s, when CDs paid up to 14%, people still wouldn't lock in rates, "because they thought they would go higher," he said. "If they had locked those in for a long period, they would have been a lot better off."
"If rates move up now, consumers are still going to want to remain relatively short," Keasling said. "Because once rates move, they believe they will continue to move higher."
