“Without geography, you’re nowhere.”
–Jimmy Buffett

You’ve Come to the Right Place
Aside from serving as a potential source of balance sheet growth, a new geographic market represents a prime, but increasingly rare opportunity to generate funds at the lowest possible marginal cost. Last month, we discussed how to identify a new geographic market. We highlighted the case of Community Sample Bank in exploring the viability of new geographic markets, using a variety of product demand and demographic analysis tools. By using Claritas P$Cycle market segmentation and deposit trend tools, available through the Seattle Bank’s Library Services, we identified a new geographic market in which our existing deposit market share was close to nil, was 150 miles away from our home market, and possessed the following positive characteristics:

• High deposits per location
• Well-established institutions losing deposit share in recent years
• Higher-than-average levels of household and income growth
• Strong household usage of deposit and fee-generating products, including high balances within brokerage liquid asset funds
• Localized media and advertising capacity that can facilitate market segmentation and distinctive geographic pricing strategies

Now that we have found an optimal market and can check off one of the “four Ps” (place), we can focus on the remaining pieces of the puzzle: price, promotion, and product. Let’s see how decentralization of these three marketing elements and a little bit of market segmentation can reduce our cost of funds.

Using Mountains, Rivers, Oceans, and Other Geographic Barriers to Your Advantage
Again, let’s consider entering the newly identified market with a de novo branch, 150 miles away from our home market. This market is geographically distinctive and disparate from our home market, quite possibly on another island, across a mountain range, or perhaps within another state.

Several months ago, in an effort to segment rate-sensitive from non-rate-sensitive customers, we launched a new promotional CD in our home market. Our hope was to preserve and enhance our rate-sensitive deposit base, while avoiding the need to pay increased rates to our non-rate-sensitive base. As demonstrated in Table 2, we launched $10-million, 13-month, off-the-run special at 3.85% with the assumption that only 20% of the category’s balances would be derived from existing depositors. Nonetheless, with market rates rising, existing depositors had become far more rate-sensitive than expected. Instead, as depicted in Table 3, 60% of the new category’s balances emanated from existing depositors. The marginal cost appeared prohibitive and the program was abruptly cancelled.

Existing CD Structure

Table 1. Existing CD Structure

Expected Results/Marginal Cost – 13-month CD Promotion

• New Funds: 80%
• Existing 9-Month CDs: 5%
• Existing 12-Month CDs: 15%
• Assumed 13-Month Wholesale Cost of Funds: 4.45%

Expected Marginal Cost: (4,046.3 – 3,730.0) / (123,000 – 115,000) = 3.95%

Actual Results/Marginal Cost – 13-month CD Promotion

Actual Sources of New 13-Month CD Category:

• New Funds: 40%
• Existing 9-Month CDs: 15%
• Existing 12-Month CDs: 45%
• Assumed 13-Month Wholesale Cost of Funds: 4.45%

Table 3. Actual CD Structure with 13-month CD Promotion

With the planned product launch of the 13-month CD program to rate-sensitive depositors in our home market, assuming cannibalization of 20% from existing depositors, the expected marginal cost of 3.95% compared favorably to the 4.45% cost of funds at the same maturity in the wholesale markets. On the surface, it would have made sense to proceed with the promotion within our existing market. In actuality, cannibalization became much higher than expected. The marginal cost of 4.47% failed to justify continuation of the program, as we were better off growing our balance sheet using wholesale funding sources.

So, what happened? First, as a deposit category, CDs tend to be more rate sensitive than other categories. Second, although we had been tracking historical rate sensitivity of previous promotions, those promotions had taken place in a lower rate environment. During a period of rising rates, previously dormant customers tend to wake up in search of better returns. In our home market, word of the new promotion got around, and customers moved lower-rate deposits out of our funding base.

Going back to our analysis of the distant market, we noted that established institutions had been losing market share. This could serve as an indication that depositors might be rate-sensitive and, therefore, potentially receptive to a new market entrant... hopefully Community Sample Bank.

Different Markets, Different Marketing
Let’s run the numbers on a revised CD promotional strategy. We’ll offer the same 12-month CD in both markets at different rates. Remembering that the marginal cost of funds is likely to be lower in untapped markets, we continue to offer the CD at 3.50% in the existing market and 4.00% in the new market. We’ll market the products locally, via print media. It’s probably not a good idea to advertise the product on the Internet, for fear of defeating the market segmentation that you are trying to achieve. Remember: by entering into a new market, you run less risk of unnecessarily paying higher rates to your existing customers.

Actual Results/Marginal Cost – New Market 12-month CD Promotion

Actual Sources of New Market 12-Month CD Category:

• New Funds: 95%
• Existing 12-Month CDs: 5%
• Assumed 12-Month Wholesale Cost of Funds: 4.40%

Table 4. Actual CD Structure with 4.00% 12-month CD Program Priced and Promoted Separately to New Market

It’s a competitive world out there. Even though we offered a 12-month CD to the new geographic market at a rate that is 50 basis points higher than in the home market, we were able to generate only $4.75 million in new money. Still, the marginal cost of this strategy, 4.03%, was less than the wholesale rate for one-year money at 4.40%.

Let’s test a joint promotion aimed at the new market: a premium-yield “New Relationship CD” for new DDA accounts with balances in excess of $50,000. We’ll locally market the 12-month New Relationship CD at a rate of 5.00%. (That’s 150 basis points higher than what is offered in our home market!) We’ll further assume that this aggressive promotion will generate $3 million in new DDAs and $7 million in 12-month CDs, with minimal cannibalization from existing accounts.

Actual Sources/Marginal Cost – New Market 12-month CD and New DDA Category

• New CD Funds: 95%
• Existing 12-Month CDs: 5%
• New DDA Funds: 100%
• Assumed 12-Month Wholesale Cost of Funds: 4.40%
• Assumed 5-Year Wholesale Cost of Funds (assumed to match DDA component): 4.80%
• Assumed Weighted Average Wholesale Cost of Funds: 4.52%

Table 5. Actual CD Structure with 5.00% 12-month CD Program Priced and Promoted Separately to New Market with DDA Account

A marginal cost of funds that’s 102 basis points below the alternative wholesale cost of funds...now, that’s the beauty of geographic segmentation. It’s all about attracting new, as opposed to existing money.

Geographic Market Segmentation and Reduced Funding Cost: A Strategy for Success
In your existing market, we saw that the marginal cost of raising funds was high because of the difficulty in attracting new funds from new depositors, as opposed to existing depositors. Nonetheless, we found that by identifying a new market with a degree of rate sensitivity and receptivity to new entrants, we were able to attract new balances without having to pay up on a large amount of existing deposits.

As is the case with any strategy, the devil is in the execution. Forging an effective geographic segmentation strategy will require: (1) a degree of distinct geographic separation, (2) price sensitivity that is higher than in your home market, (3) heretofore limited or non-existent share within the new market, (4) highly selective and localized marketing.

Even in today’s ever-shrinking world, it helps to have a degree or two of separation between your existing and potentially new markets. Maybe it’s a simply matter of a change in latitude and a change in attitude!

John Biestman is assistant vice president, IMS consultative sales advisor at the Federal Home Loan Bank of Seattle.

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