Developing Deposit Strategies for Rising Rates Session 2. Agenda

Transcription

1 Developing Deposit Strategies for Rising Rates Session 2 Thomas A. Farin President tfarin@farin.com 1 Agenda Session 1 - Deposit Analytics Are We In a Rising Rate Environment? Establishing Cash Flows Contractual vs. Actual Behavior Pricing Betas Decay Rates Surge Balances Methods for Calculating Decay Rates Session 2 Determining Where to Grow Deposits Where are your loan growth opportunities? How Will You Fund Loan Growth? Determine Where You Will Grow Deposits Blending Retail and Wholesale Funding Session 3 Developing Segmentation Strategies CDs Basics Barriers to Entry Non-Maturity Deposits Basics Barriers to Entry Surge Balances 2 1

2 Rising Rates - 6 Keys #1 #2 #2&3 1. Develop a Capital Plan Asset Growth Goals Loan Growth Goals Funding Growth Goals 2. Get a Handle on your MND & CD Behaviors 3. Identify Loan Growth Opportunities 4. Consider How to Fund Loan Growth 5. Determine Where You Will Grow Deposits 6. Learn How to Segment Effectively 3 Chicago Case Institution $1.5 Billion Deposits Had been shrinking Capital Plan allows $30-50 million asset growth in 2014 Loan/Asset Ratio is low Loans can grow more than deposits Needs to grow to drive down Non-earning assets/assets Operating expenses/assets Growth for now goes into investments at relatively low yield Pressure is for growth to be at low marginal cost Where should he grow funding Wholesale funding Retail funding 4 2

3 Identify Loan Growth Opportunities Case Institution 15 and 30 Year FRMS Conforming Non-Conforming Fully Amortizing Commercial R/E Loans 15 Year FRM 20 Year FRM But, Farin, there is too much interest rate risk in these products! After all, isn t that what caused thrifts to fail? So we take interest rate risk we could manage and pass it to the customer who can t manage IRR. What do we get back? Why can t we figure this out? 5 Outtake: Lessons from the Thrift Crisis The first round of thrift failures were interest rate risk related. The second round was credit risk related. The bulk of 1 st round failures were big CD shops Portfolioed LT Fixed-rate mortgages - QTL test Funded with 4,6, & 8 Year CDs Reg Q set maximum rates allowed on all deposit products. Congress decided to deregulate the deposit side first First new instrument out the door was the 6 month MM CD, the first deposit instrument where maximum rate allowed was driven off 6 month Treasury at time of issue. Early withdrawal penalties were also written into the regulation. 6 3

4 Outtake: Lessons from the Thrift Crisis Rates went up, taking the origination rate on the 6 Month MM CD above maximum rates allowed under law in 4,6, & 8 year CDs. 70s Version of Going Viral Jane Bryan Quinn writes articles in WSJ encouraging customers to take the penalty on LT CDs and reinvest in 6 month MM CD They did so in droves. Now we have 30 Year FRMS funded with 6 Month MM CDS. Then rates really went up. Costs of funds went up much faster than yields causing many thrifts to fail. Meanwhile shops with majority of deposits in NMDs didn t pay up on NMDs, the money stuck and their margins were just fine. 7 Consider How to Fund Loan Growth Case Institution Deposits Long-Term CDs Recently Expensive Will lag the market in rising rate environments Uncovered Options Non-Maturity Deposits Cheap source of longterm funding especially when rates are up. But do you bet the whole shop on the results of a core study? FHLB Advances Relatively cheap now Will lead deposit rates in rising rate environment Can be purchased With no imbedded options With options granted to the FHLB (cheaper) With imbedded options granted to the member (more expensive) Can raise exactly what you need, at a known rate, when you need it Requires collateral SWAPs, CAPs and other off balance-sheet instruments 8 4

5 Determine Where You Will Grow Deposits Short-Term CDs High Beta Short Lags Cost of Funds Goes Up Quickly Segmentation Strategies Less Effective IRR Short-Term Funding Long-Term CDs High Beta on Renewing/New Money but Low Roll Short Lags Cost of Funds goes up More Slowly Except Are Early Withdrawal Penalties Adequate? Segmentation Strategies Less Effective IRR Long-Term Funding But Savings/Money Market Lower Beta Generally Longer Lag Cost of Funds Increases Immediately Segmentation Strategies Powerful IRR Mix Rate Sensitive/NRS Checking Generally Lowest Beta Generally Longer Lag Cost of Funds Increases Immediately Segmentation Strategies Could be Powerful IRR Mix Rate Sensitive/NRS How do you grow checking? 9 Farin Core Study - Betas Good Funding Source for LT FR Loans as Long As They are LT 10 5

6 Farin Core Studies Surges Surges Most don t represent a liquidity threat, instead they are a cost of funds threat as they will move back into CDs with rising rates. Need to knock surges out of low beta funding sources. 11 Farin Core Studies Decay Rates Remaining low beta funding sources (after surge knock outs) are long-term funding at a relatively fixed rate. 12 6

7 Farin Core Study Surges vs Core Betas LT FR Funding 13 Questions Is management willing to Bet the Bank on a Core Deposit Study? Your career could be at stake. How will your regulator react to funding long-term fixedrate loans entirely with non-maturity deposits? Your CAMEL(S) rating could be at stake. Can you convince your Board of Directors that this strategy makes sense? Especially if you ve told them that portfolioing fixed-rate loans is stupid, especially at the bottom of the rate cycle. Is there a better approach? 14 7

8 Blended Funding Using FHLB Advances Concept Use FHLB Advances to provide structural support under fixed-rate loans Partially match the cash flows with totally predictable funding behavior Potentially pay a bit more for prepayment protection Tradeoffs Higher cost You may not need the funding But what are you earning on your investment portfolio now? Supplement FHLB Advances with non-maturity deposits to plug funding gap taking advantage of: Low cost of NMDs Lower pricing betas through segmentation Decay rates Inherent extension risk hedge Results in: A close to fully hedged position Less reliance on the accuracy of the core study 15 FHLB Topeka Blended Funding 40/60 Yield 5.5% Blend Cost 1.9% Spread 3.6% Core Study Reliance 60% 16 8

9 FHLB Topeka Blended Funding 70/30 Yield 5.5% Blend Cost 2.8% Spread 2.7% Core Study Reliance 30% Cost of additional Locked hedge 1% 17 Moving from Case to Reality This is a case specific solution Kinds of loan growth anticipated LT FR Loans Deposit funding selection Core NMDs Advance chosen for blended funding Amortizing advance But it is the most outside the box hedge I could anticipate you considering Applying to your situation May be different loan growth opportunity Might choose a different deposit funding type May not need to use advances for support Likely to be more inside the box In all cases, anything you can do to reduce cost of funds impact in rising rates would allow you to fund longer-term assets at a lower funding cost. 18 9

10 Determine Where You Will Grow Deposits Short-Term CDs High Beta Short Lags Cost of Funds Goes Up Quickly Segmentation Strategies Less Effective IRR Short-Term Funding Long-Term CDs High Beta on Renewing/New Money but Low Roll Short Lags Cost of Funds goes up More Slowly Except Are Early Withdrawal Penalties Adequate? Segmentation Strategies Less Effective IRR Long-Term Funding But Savings/Money Market Lower Beta Generally Longer Lag Cost of Funds Increases Immediately Segmentation Strategies Powerful IRR Mix Rate Sensitive/NRS Checking Generally Lowest Beta Generally Longer Lag Cost of Funds Increases Immediately Segmentation Strategies Could be Powerful IRR Mix Rate Sensitive/NRS How do you grow checking? Let s attack deposit segmentation one sector at a time with a focus on rising rates Learn How To Segment Effectively Segmentation Goals Pay Up for Rate Sensitive Funds Don t Pay Up for Non-Rate Sensitive Funds Use Barriers to Entry to Block Cannibalization into Premium Products Reducing Combined Beta Geographic Minimum Balance or Tiering New Money Transaction Barriers Channel Barriers Stealth Products 20 10

11 Chicago Customer ST CD Competitive Rates by Sector Month CD as of Oct How much would I need to raise rates to grow here? Prom Std Us 50% (0.16) *Marquette 1st Mid 5/3ArcherBofA Bridge Charter Chase Citi First FirstMeritH MB National Cit PrivateBank Old Old Republic Standart SB TCF U.S. Americ B ar- Plank Second Ban Bank Month CD 21 Rate Trends ST (10-15 Mo) CDs Rate Trends by Sector Month CD Mkt Range Mkt Low Average FHLB Advance - 12 M 50 Pct 12 Mo CD

12 Pay Up - Offensive Some runoff of existing customers, but surge balances replace those funds. Less runoff of existing Customers, but surge balances and new money more than replace those funds. Would save 4.15% at the margin if funds were borrowed from FHLB Chicago. 23 CD Special - Defensive Saves $350,000 by paying less on non-rate sensitive funds while paying up for rate sensitive funds. Average cost from 2.17% to 1.94%. Beta reduced from 1.0 to

13 CD Special - Offensive Marginal Cost comes in below benchmark as a result of not paying up for non-rate sensitive funds. Average cost down from 2.17% to 2.16% in spite of $15 million of new funds. Beta reduced from 1.0 to 0.99 in spite of more aggressive pricing. 25 CD Special Offensive Tiered Barrier Less new money raised Offensive Defensive Lower marginal cost and beta 26 13

14 CD Special Offensive - Geographic Offensive Defensive Assumes high market share in Market A and low market share in Market B 27 CD Special Offensive New Money Retains higher percentage of existing CDs. Will raise similar amount of new less runoff of existing rate sensitive customers that can t meet or are unwilling to Meet new money requirement

15 Long-Term CDs Segmentation strategies are similar to those with short-term CDs except: There may be more sleepy money (less cannibalization). Segmentation strategies take longer to have an effect Lower CD turnover because of laddered term structure. Generally a lower percentage of funding. Issues relating to effectiveness of early withdrawal penalties. Generally I recommend: Avoiding aggressively pricing CDS of 36 months or more, which means keep your specials relatively short. 29 Penalty Effectiveness Calculator A B C Customer Exercises Option Immediately Customer Exercises Option After 12 Months Note: A 6 month penalty would provide ½ of the shock protection 30 15

16 60 Mo CD - Chicago Metro Market bp 5 year FHLB Advance + 45 bp Top Rate Median Rate Wholesale +120 bp, Retail +45 bp Rising Rates - 6 Keys #1 #2 #3 1. Develop a Capital Plan Asset Growth Goals Loan Growth Goals Funding Growth Goals 2. Get a Handle on your MND & CD Behaviors 3. Identify Loan Growth Opportunities 4. Consider How to Fund Loan Growth 5. Determine Where You Will Grow Deposits 6. Learn How to Segment Effectively 32 16