Developing a Funding Strategy for Rising Rates. Agenda

Transcription

1 Developing a Funding Strategy for Rising Rates Thomas Farin Chairman tfarin@farin.com 1 Agenda Session 1: Lay out a best practices funding and pricing process? Identify internal issues impacting risk profile and earnings in current nonmaturity deposit modeling Using results of core deposit study in decision making Session 2 Managing CD Portfolios CD Behaviors Using CD Segmentation Strategies to Grow/Maintain Deposits Session 3: Non-Maturity Deposit Strategies How can I make the loans my borrowers want? Using Blended Funding to Fund Long-Term Assets on the Cheap 2 1

2 Session 1 Process and Analytics 3 Strategy What Are Our Deposit Goals? Growth goals Loans Assets Deposits What kinds of deposit growth do we want CDs? NMDs What are we attempting to fund? 4 2

3 Best Practices Pricing Process Tactical and Strategic Cycle Strategic Quarterly review cycle Frequent enough to deal with competitor initiatives Ties pricing into ALCO Horizon lives within lag relationship between retail and wholesale, so deposit strategies don t require an economic crystal ball. Tactical Weekly pricing decisions Frequent enough to deal with market rate changes Administers strategies developed as part of strategic review 5 Best Practices Deposit Pricing Process Initial Strategic Review (ISR) Define Sectors Break products into sectors Review product offerings Develop pricing strategy Develop marketing strategy Implement tracking systems Contingency plans Subsequent to the Initial Strategic Review (Tactical) Execute Strategies in Initial Strategic Review Pricing Changes Product introduction Install an Effective Tactical process Review of Trends Pricing Decisions - Decision Tree ALCO Committee Pricing Committee Closing the Loop with a QSR & ASR Review of Trends Rates Paid Balances Supplied Competitive/Wholesale Rates Back Test Marginal Cost of Funds Raised Develop Modified Strategies Revisions to Product Offerings Revisions to Pricing Rules Changes to marketing Strategy Contingency plans 6 3

4 Initial Strategic Review Step 1: Divide deposit accounts into sectors. You may want to start out with four funding sectors: Checking accounts Savings and MMDA Short-term CDs Long-term CDs Accounts with roughly the same utility to customers. Once they are grouped, review product offerings Is there opportunity to effectively segment customers within this sector? Are customer constituencies with specific needs or behaviors addressed with products designed to meet their needs? 7 Initial Strategic Review Step 2: Develop a pricing strategy for each sector. What is a pricing strategy? Part 1: The account structure (value propositions) within the sector. Example: ST CD Sector 3 Month CD 6 Month CD 12 Month CD Off-Maturity Special Note that the account offerings in this short-term CD sector Recognize that CDs don t act like the contract implies Provide an opportunity to separate rate sensitive from non-rate sensitive funds Are unlikely to segment when account is opened but if properly designed will segment at maturity. 8 4

5 Initial Strategic Review Part 2 Develop the Pricing Rules for the sector. Pricing rules Define how the accounts are priced relative to each other and to competitive and wholesale rates Will normally be in place for a quarter so should state relationships in relative terms Will be used in making tactical decisions during the quarter. Example - Price all regular CDs in this sector at the bottom quartile of the market based on survey data. Price the special at or near the top of the market but no higher than the 1 year FHLB Advance rate. 9 Initial Strategic Review Leads to New Product Introduction Results in Pricing Rules for Each Sector In addition it should (for each sector) Reflect the general marketing approach Identify key metrics to be measured Identify potential contingency plans should the unexpected happen during the quarter Lays out the plan for implementation 10 5

6 Price / Demand Effective Tracking Systems Pricing Consistent With Strategy? Hitting Demand Goals? Cost Effectiveness of Strategy Cannibalization New Money 11 Rate Trends Rate Trends Month CD Mkt Range Mkt Low 1 Year FHLB Advance Atlanta Our High Median Our Low ISR IstQSR 2 nd QSR /15/ /22/ /29/ /6/ /13/ /20/ /27/2006 1/3/2007 1/10/2007 1/17/2007 1/24/2007 1/31/2007 2/7/2007 2/14/2007 2/21/2007 2/28/2007 3/7/2007 3/14/2007 3/21/2007 3/28/2007 4/4/2007 4/11/2007 4/18/2007 4/25/2007 5/2/2007 5/9/2007 5/16/2007 5/23/2007 5/30/2007 6/6/2007 6/13/2007 6/20/2007 6/27/2007 7/4/2007 7/11/2007 7/18/2007 7/25/2007 8/1/

7 Volume Trends Balance Trends by Sector Sum of balance ISR IstQSR 2 nd QSR type Actual /1/ /13/ /20/ /31/2006 1/3/2007 1/10/2007 1/17/2007 1/24/2007 1/31/2007 2/7/2007 2/14/2007 2/21/2007 2/28/2007 3/7/2007 3/14/2007 3/21/2007 3/28/2007 4/4/2007 4/11/2007 4/18/2007 4/25/2007 5/2/2007 5/9/2007 5/16/2007 5/23/2007 5/30/2007 6/6/2007 6/13/2007 6/20/2007 6/27/2007 7/4/2007 7/11/2007 7/18/2007 7/25/2007 8/1/2007 8/8/2007 8/15/2007 8/22/2007 8/29/ Month CD sector date 13 Cannibalization Trends Balance Trends by Sector Sum of balance Balances Off On type Actual /25/2007 5/2/2007 5/9/2007 5/16/2007 5/23/2007 5/30/2007 6/6/2007 6/13/2007 6/20/2007 6/27/2007 7/4/2007 7/11/2007 7/18/2007 7/25/2007 8/1/2007 8/8/2007 8/15/2007 8/22/2007 8/29/2007 4/25/2007 5/2/2007 5/9/2007 5/16/2007 5/23/2007 5/30/2007 6/6/2007 6/13/2007 6/20/2007 6/27/2007 7/4/2007 7/11/2007 7/18/2007 7/25/2007 8/1/2007 8/8/2007 8/15/2007 8/22/2007 8/29/2007 4/25/2007 5/2/2007 5/9/2007 5/16/2007 5/23/2007 5/30/2007 6/6/2007 6/13/2007 6/20/2007 6/27/2007 7/4/2007 7/11/2007 7/18/2007 7/25/2007 8/1/2007 8/8/2007 8/15/2007 8/22/2007 8/29/2007 4/25/2007 5/2/2007 5/9/2007 5/16/2007 5/23/2007 5/30/2007 6/6/2007 6/13/2007 6/20/2007 6/27/2007 7/4/2007 7/11/2007 7/18/2007 7/25/ Mo CD 12 Mo CD Jumbo 14 Mo Special 14 Mo Special Jumbo Month CD sector account date 8/1/2007 8/8/2007 8/15/2007 8/22/2007 8/29/

8 Core Deposit Study - Pricing Betas Definition A pricing beta is a variable that is used to predict the effect of an increase in market rates on rates paid on a product. For example, if market rates increase 200 bp and your beta for MMDAs is 0.5 (50%) then the beta would predict you will raise MMDA rates by 100 bp 200 Bp X 0.5 = 100 Bp Betas can be: SWAG d Derived statistically from historic data. Examiners prefer the latter Betas can also be modified by use of segmentation strategies. 15 How Betas Play Out in Industry 1.0 Lag Premium MMDA & CD Regular Savings

9 Pricing Betas a = 0.4% b =.75 Y = a + bx = Rate Paid 17 Pricing Betas Questions: 1. Which of these cost of funds profiles would you prefer to have 2. What would that information allow you to do with asset and fu 18 9

10 Core Study Beta Results Study uses a variety of indexes, lags and results show betas ranging from to Effect of Beta Study on Deposit Rates with 200 bp Ramp Over 12 Months It doesn t matter how long this funding is around, it is variable rate 20 10

11 Pricing Beta Conclusions Applications A/L Modeling Income at Risk Value at Risk (core deposit intangible) Funding strategy development Credibility Issues Do you really price MMDAs off 2 year Treasury? What issues rise when historical betas are used to predict the future? Betas affected by Growth/Shrinkage Strategies Tier Structure Betas for different tiers will be different Segmentation Strategies Account Groupings Consumer Preferences Competitive/economic environment Betas Apply to CDs Non-maturity deposits 21 Farin Core Study - Betas 22 11

12 Non-Maturity Deposits Actual Behaviors Rates on some of these accounts respond moderately and slowly in response to changes in market rates Balances are retained for long periods of time in spite of rate behavior Acts like: Stable supply, semifixed rate, long-term Actual Counterpart laddered portfolio of fixed-rate long-term CDs Segmentation Strategies Rates respond very slowly to changes in market rates on non-rate sensitive portion Rates respond more quickly to changes in market rates on rate sensitive portion Weighted average cost moves relatively slowly in response to changes in market rates Lots of barrier to entry options Product design Tiers Transactional Channel Is the term of non-maturity deposits important as we head into a rising rate environment? 23 Non-Maturity Deposit Life Key Concept Non-maturity deposits don t all mature at the same time Instead, balances in accounts decay off the books over time Decay rates can be statistically measured Once measured, decay rates can be used to forecast cash flows coming off pools of non-maturity deposits For all these reasons, your decay rates could be dramatically different than national averages. Cash Flow Decay rates affected by: Life events death, divorce, population turnover Satisfaction with the institution Movements in market rates and your pricing strategy. Economic events local (plant closings), and national (911, stock market health, economic outlook, etc.) Technology Interaction between CSRs and customers Flight to quality Relationship between CD and NMD rates 24 12

13 Farin Core Studies Surges 25 Farin Core Studies Decay Rates 26 13

14 Surge & Decay Surge balances can vary considerably. Betas on surge balances are very high as the customer will reprice the balances for you. Decay rates seem low until you consider we are looking at balance decays rather than account number decays. This is just regulatory BS 27 Best Decay Rate Methods Single pool account study Most common approach Track changes in initial study group accounts over time. Calculate the changes in account balances and # of account on accounts Strengths Able to correlate changes in actual accounts and balances Recognized as industry standard Weaknesses Data required from pre-crisis starting point (2007 or earlier) for most relevant analysis Ignores all new accounts Applies old account behaviors to all newly opened accounts 28 14

15 Best Decay Rate Methods Emerging Standard: Multi Pool (Vintage) Track initial study group (single pool method) and subsequent pools of new accounts over time Track behaviors of newer accounts vs. older more seasoned accounts Strengths Doesn t ignore accounts representing > 50% of total deposit balances in a sector Develops better metrics on new account behaviors Helps to estimate surge deposits vs. core Weaknesses More data and analysis required Many ALM models unable to process outputs properly vs 29 Surge-Adjusted Decays What happens when the remaining balances from study group represent an insignificant amount compared to total balances? 30 15

16 MMDA Net Avg Balance Avg balance of newer depositors greater and more VOLATILE than old study accounts. Do the new accounts act like the old? 31 MMDA Remaining Balance Newer depositors controlling greater amount of total deposits 32 16

17 Compare Beginning Balances (using Vintage Study) In this example the initial vintage has a higher & very stable average balance trend. Subsequent vintages grow over time. What might cause this? 33 Market Value Sensitivity Today s market values are well below book. What will happen if rates go up on accounts with high betas and high surge percentages? 34 17

18 Weighted Average Life Argument WALs only look at principal life & drop when rates rise as surges run off. Since WALs fail to consider betas (interest expense cash flows), they aren t a very good measure of hedging power of NMDs. 35 Effective Duration - Core Eff Dur = - Chg MV / Chg MR Effective Duration looks at how the principal and interest cash flows are affected by changes in rates and considers decay rates, surge balances, truncation, and pricing betas. These are effective durations of non-surge (core) balances 36 18

19 Effective Duration - Core Auto Loans 15 Yr FRM 30 Yr FRM 37 Effective Duration - Surge The effective durations of surge balances are negative. When surge balances come out of the NMD, they come out at par

20 Effective Duration - Surge Good sources for HELOCs, credit cards, other VR loans Note as surge balances run off they are likely to move into CDs 1 yr, 2 yr, 3 yr, etc. 39 FARIN s Enterprise Risk Management Framework Our solutions Managed services In-house solutions Hybrid options Interest rate risk Static & dynamic approach Advisory & educational services Capital planning Capital plan development Integrated stress testing Capital buffer calculations Credit Services Dual loan grading model Loan pricing review and modeling ALLL calculation Loan migration analysis Credit stress testing Liquidity risk Core funding strategy development Deposit pricing and segmentation assistance Stress & back testing Policy & education 40 20

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