Deposit Pricing in Rising Rates Session 2

Transcription

1 Deposit Pricing in Rising Rates Session 2 Thomas Farin Chairman of the Board tfarin@farin.com 1

2 Three Part Series Session 1 The Deposit Toolkit Are we already in a rising rate environment? Effective Process Deposit Analysis Tools Betas Decay Rates Surge Balances Marginal Cost Sensitivity Analysis Profitability Analysis Session 2 CD Strategies CD characteristics Early WD penalties CD segmentation Basic special Use Employing barriers to entry Exception Pricing Session 3 NMD Strategies MM segmentation Basic Segmentaion Teaser rate strategies Creating low beta non-surge balances Surge balance retention Checking strategies 2

3 CDs Contractual Behaviors Generally fixed rate Stated term Early withdrawal penalty Automatic renewal General Rule The more features of an account that are important to a customer other than rate, the less sensitive they will be to rate paid CD Features Rate Term Penalty Actual Behaviors Rates on some of these accounts respond relatively quickly in response to changes in market rates Balances stay with the institution after maturity 65% to 85% of the time. Acts like: Stable supply, variable rate (reprices at renewal), long-term Actual Counterpart Adjustable-rate mortgage Key Inputs to A/L Model How much will you raise rates as market rates increase? Farin &

4 Learning 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 4

5 ST CD Competitive Pricing Example Competitive Rates by Sector Month CD as of Oct How much would I need to raise rates to grow here? *Marquette 1st Mid 5/3ArcherBofA Bridge Charter Chase Citi First FirstMerit Americ B H ar- MB National Cit PrivateBank Old Old Republic Standart SB TCF U.S. Plank Second Ban Bank Month CD Prom Std Us 50% (0.16) 5

6 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

7 CDs - High Cost of Paying Up CDs - Cost of Paying Up Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 90% 9, % 100% 10, Month CD 0.15% 30, % 90% 27, % 100% 30, Year CD 0.20% 60, % 90% 54, % 100% 60, Strategy 1: Don t react $10 mm runoff Strategy 2: Pay up No runoff Total/Average 0.18% 100, % 90% 90, % 100% 100,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 90, % 0.60% 0.43% - IB Checking 2.50 Strategy 2 100, % 0.60% 0.03% 1.00 MMDA 1.50 Marginal Cost 10, % 0.60% 3.58% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $0 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $418 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 4.18%. Benchmark is 0.60%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 0.40% etc. Marginal cost of holding onto $7.5 million is 2.18%, 1.58% over benchmark Rates up 40 bp Benchmark moves from 20 bp to 60 bp.

8 CDs - High Cost of Paying Up CDs - Cost of Paying Up Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 90% 9, % 100% 10, Month CD 0.15% 30, % 90% 27, % 100% 30, Year CD 0.20% 60, % 90% 54, % 100% 60, Strategy 1: Don t react $7.5 mm runoff Strategy 2: Pay up No runoff Total/Average 0.18% 100, % 90% 90, % 100% 100,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 90, % 0.60% 0.43% - IB Checking 2.50 Strategy 2 100, % 0.60% 0.03% 1.00 MMDA 1.50 Marginal Cost 10, % 0.60% 3.58% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $0 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $418 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 4.18%. Benchmark is 0.60%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 0.40% etc. Marginal cost of holding onto $10 million is 4.18%, 3.58% over benchmark Rates up 40 bp Benchmark moves from 20 bp to 60 bp.

9 CDs - Advantage of Defensive Segmentation CDs - Deploying CD Special Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 90% 9, % 85% 8,500-6 Month CD 0.15% 30, % 90% 27, % 85% 25,500-1 Year CD 0.20% 60, % 90% 54, % 85% 51, Month CD Special 0.60% 15,000 Strategy 1: Don t react $7.5 mm runoff Total/Average 0.18% 100, % 90% 90, % 100% 100,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 90, % 0.60% 0.43% - IB Checking 2.50 Strategy 2 100, % 0.60% 0.36% 0.16 MMDA 1.50 Marginal Cost 10, % 0.60% 0.21% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $0 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $81 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 0.81%. Benchmark is 0.60%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 0.40% etc. Strategy 2: Run Special Assumes 40% cannibalization No runoff Marginal cost of holding onto $7.5 million is 1.21%, 0.61% over benchmark Rates up 40 bp Benchmark moves from 20 bp to 60 bp. Would you retain retail funds or replace with wholesale?

10 CDs - Advantage of Defensive Segmentation CDs - Deploying CD Special Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 90% 9, % 85% 8,500-6 Month CD 0.15% 30, % 90% 27, % 85% 25,500-1 Year CD 0.20% 60, % 90% 54, % 85% 51, Month CD Special 0.60% 15,000 Strategy 1: Don t react $7.5 mm runoff Strategy 2: Run Special Assumes 15% cannibalization No runoff Total/Average 0.18% 100, % 90% 90, % 100% 100,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 90, % 0.60% 0.43% - IB Checking 2.50 Strategy 2 100, % 0.60% 0.36% 0.16 MMDA 1.50 Marginal Cost 10, % 0.60% 0.21% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $0 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $81 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 0.81%. Benchmark is 0.60%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 0.40% etc. Rates up 40 bp Benchmark moves from 20 bp to 60 bp. Marginal cost of holding onto $10 million is 0.81%, 0.21% over benchmark Would you retain retail funds or replace with wholesale?

11 CDs - Segmentation Defensive vs. Offensive Strategy 1: Run Defensive Special Assumes 40% cannibalization No New Money Strategy 2: Run Offensive Special Assumes 40% cannibalization $5 mm New Money Marginal cost of $5 million new money is 1.56%, 0.96% over benchmark Rates up 40 bp Benchmark moves from 20 bp to 60 bp. Would you grow with retail funds or wholesale?

12 CDs - Segmentation Defensive vs. Offensive Strategy 1: Run Defensive Special Assumes 40% cannibalization No New Money Strategy 2: Run Offensive Special Assumes 40% cannibalization $5 mm New Money Marginal cost of $5 million new money is 1.56%, 0.96% over benchmark Rates up 40 bp Benchmark moves from 20 bp to 60 bp. Would you grow with retail funds or wholesale?

13 Pay Up vs Special (+200 bp) CDs - Pay Up vs.special (200bp) Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 100% 10, % 75% 7, Month CD 0.15% 30, % 100% 30, % 65% 19, Year CD 0.20% 60, % 100% 60, % 60% 36, Month CD Special 0.00% 2.20% 37,000 Strategy 1: Assumes 100% retention No new money Total/Average 0.18% 100, % 100% 100, % 100% 100,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 100,000 2, % 2.20% 0.03% 1.00 IB Checking 2.50 Strategy 2 100,000 1, % 2.20% 0.33% 0.85 MMDA 1.50 Marginal Cost - (307) 0.00% 2.20% -2.20% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 ran off 0 thousand of funds. 3 Month CD 0.25 Interest expense decreased by 307 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 0.00%. Benchmark is 2.20%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 2.00% etc. Strategy 2: Run Defensive Special Assumes 37% cannibalization No new money Saves $307K, 31 bp 13

14 Offensive vs Defensive Special (+200 bp) CDs - Def vs. Off Special (200bp) Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 75% 7, % 75% 7, Month CD 0.15% 30, % 65% 19, % 65% 19, Year CD 0.20% 60, % 60% 36, % 60% 36, Month CD Special 2.20% 37, % 52,000 Strategy 1: Defensive special no new money Total/Average 0.18% 100, % 100% 100, % 115% 115,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 100,000 1, % 2.20% 0.33% 0.85 IB Checking 2.50 Strategy 2 115,000 2, % 2.20% 0.11% 0.96 MMDA 1.50 Marginal Cost 15, % 2.20% 1.39% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $15000 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $538 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 3.59%. Benchmark is 2.20%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 2.00% etc. Strategy 2: Run offensive special $15K new money Marginal cost 3.59%, 139 bp above benchmark. If you need to raise new funds, doing so with CDs can be very expensive. 14

15 CDs - Lessons from This Series Marginal cost will always be lower if you segment as opposed to paying up. That means you need to have decided on your strategy before rates begin to rise which prepares you for Deploying the segmentation strategy when first drip happens. Marginal cost of attracting and retaining rate sensitive CD customers is high. It is even higher for new CDs.

16 Learning 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 16

17 Tiered vs Defensive Special (+200 bp) CDs - Def vs. Tiered (200bp) Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 75% 7, % 75% 7, Month CD 0.15% 30, % 65% 19, % 65% 19, Year CD 0.20% 60, % 60% 36, % 60% 36, Month CD Special <$50K 2.20% 37, % 15, Month CD Special >=$50K 2.60% 32,000 Total/Average 0.18% 100, % 100% 100, % 110% 110,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 100,000 1, % 2.20% 0.33% 0.85 IB Checking 2.50 Strategy 2 110,000 2, % 2.20% 0.19% 0.92 MMDA 1.50 Marginal Cost 10, % 2.20% 1.28% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $0 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $348 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 3.48%. Benchmark is 2.20%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 2.00% etc. Strategy 1: Defensive special no new money Strategy 2: Defensive <$50 Offensive >=$50K $10K new money Marginal cost 3.48%, 118 bp above benchmark. If you need to raise new funds, doing so with CDs can be very expensive. 17

18 Geographic vs Defensive Special (+200 bp) CDs - Def vs. Geographic (200bp) Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD - A 0.10% 8, % 75% 6, % 75% 6, Month CD - A 0.15% 24, % 65% 15, % 65% 15, Year CD - A 0.20% 48, % 60% 28, % 60% 28, Month CD Special - A 2.20% 29, % 29,600 3 Month CD - B 0.10% 2, % 75% 1, % 1, Month CD - B 0.15% 6, % 65% 3, % 3, Year CD - B 0.20% 12, % 60% 7, % 7, Month CD Special - B 2.20% 7, % 18,000 Total/Average 0.18% 100, % 100% 100, % 111% 110,600 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 100,000 1, % 2.20% 0.33% 0.85 IB Checking 2.50 Strategy 2 110,600 2, % 2.20% 0.20% 0.91 MMDA 1.50 Marginal Cost 10, % 2.20% 1.02% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $10600 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $341 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 3.22%. Benchmark is 2.20%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 2.00% etc. Strategy 1: Defensive special no new money Strategy 2: Defensive Mkt A Offensive MktB $10.6K new money Marginal cost 3.22%, 102 bp above benchmark. If you need to raise new funds, doing so with CDs can be very expensive. 18

19 New Money vs Defensive Special (+200 bp) CDs - Def vs. New Money (200bp) Current Strategy 1 Strategy 2 Account Rate Maturities Rate Ret % Ret $ Beta Rate Ret % Ret $ Beta 3 Month CD 0.10% 10, % 75% 7, % 75% 7, Month CD 0.15% 30, % 65% 19, % 65% 19, Year CD 0.20% 60, % 60% 36, % 60% 36, Mo CD Special - No New Money 2.20% 37, % 32, Mo CD Special - New Money 2.60% 20,000 Strategy 1: Defensive special no new money Total/Average 0.18% 100, % 100% 100, % 115% 115,000 Balance Expense Cost Bnchmk Spread Beta Ballpark Duration (years) Strategy 1 100,000 1, % 2.20% 0.33% 0.85 IB Checking 2.50 Strategy 2 115,000 2, % 2.20% 0.22% 0.90 MMDA 1.50 Marginal Cost 15, % 2.20% 0.53% Reg Savings 2.50 Marginal Cost Model Summary NIB Checking 2.50 Strategy 2 raised $15000 thousand of new funds. 3 Month CD 0.25 Interest expense increased by $410 thousand. 6 Month CD 0.50 Marginal cost of the additional funds was 2.73%. Benchmark is 2.20%. 1 Year CD Year CD Farin & Associates, Inc. Mkt Rate Increase 2.00% etc. Strategy 2: Defensive No New Offensive New $15K new money Marginal cost 2.73%, 53 bp above benchmark. If you need to raise new funds, doing so with CDs can be very expensive. 19

20 What Happens If? You ve been through the effects of the financial crisis. Ran off rate sensitive single relationship funding (primarily CDs, some MMDAs) You are fairly liquid as loan demand hasn t taken off Core customers are coming to you and asking how long they should hang on with your rates well below market. Solution: Consistently applied well thought through exception pricing policy.

21 Exception Pricing Posture Defensive hold onto what you have Understand most of your economic value is in nonmaturity deposits the least rate sensitive funding you have. Most rate sensitive are CDs and high tier/premium money markets. Do you know how much non-maturity funding is required to support exception rates on MMDAs and CDs?

22 Exception Pricing Example 12 month CD shows a negative ROA because all-in cost is above the FHLB benchmark rate. Customer is asking for a better rate of 0.80%. Clearly if this is a single Relationship CD, the answer should be no. But what if the customer also has an active checking account?

23 Exception Pricing Example Checking account has an average collected balance Of $5,000 and produces $45.00 in annual interchange income and $120 in annual overdraft Income. Checking account ROA Is 7.29%. Average cost With amortized fees is 7.68% below benchmark.

24 Exception Pricing Example Checking account has an average collected balance Of $5,000 and produces $45.00 in annual interchange income and $120 in annual overdraft Income. Checking account ROA Is 7.29%. Average cost With amortized fees is 7.68% below benchmark. Checking account pulls relationship ROA up to 2.45%.

25 Exception Pricing Example 40 BP exception on the 12 month CD takes rate from 0.40% to 0.80%. ROA on the CD drops to = 0.73%. But relationship return is still 2.11%. If the customer relationship is at risk, it makes sense to approve the exception.

26 CDs - Lessons from This Series Barriers to entry as part of segmentation strategy can reduce marginal cost Most effective barriers in this sequence are: New money special Well thought through exception pricing strategy Marginal cost of attracting and retaining rate sensitive CD customers is high even with creative use of barriers to entry.

27 Long-Term CDs All of the techniques discussed apply to long-term CDs, but keep in mind Balances may be lower Turnover is definitely lower Effective early withdrawal penalties need to be in place if you are going to aggressively pursue long-term CDs. 27

28 Penalty Effectiveness 5 Yr CD Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 0 Penalty Amount - Months 12 Annual Penalty In BP 30 Amount of Shock Protection (BP) 30 5 Yr CD at original term 12 Mo Penalty If long-term rates go up more than 30 bp, customer s early withdrawal option goes in the money. 28

29 Penalty Effectiveness 5 Yr CD Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 0 Penalty Amount - Months 24 Annual Penalty In BP 60 Amount of Shock Protection (BP) 60 5 Yr CD at original term 24 Mo Penalty Doubling the penalty doubles the protection. But is it enough? 29

30 Penalty Effectiveness 5 Yr CD Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 5.00% Penalty Type - (0) Months or (1) % of Principal 0 Penalty Amount - Months 24 Annual Penalty In BP 200 Amount of Shock Protection (BP) Yr CD at original term 24 Mo Penalty Penalties of days interest are much more effective when rates go up. But it is when rates are low that we need the penalty the most. And when rates are up, we remain need them the least. 30

31 Penalty Effectiveness 5 Yr CD Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 0 Penalty Amount - Months 24 Annual Penalty In BP 60 Amount of Shock Protection (BP) 60 Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 36 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 0 Penalty Amount - Months 24 Annual Penalty In BP 100 Amount of Shock Protection (BP) Yr CD at original term 24 Mo Penalty 5 Yr CD at remaining term 24 Mo Penalty As remaining term of CD gets lower, penalty effectiveness gets higher. 31

32 Penalty Effectiveness 5 Yr CD Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 0 Penalty Amount - Months 24 Annual Penalty In BP 60 Amount of Shock Protection (BP) 60 5 Yr CD at original term 24 Mo Penalty Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 1 Penalty Amount - % of Principal 5 Annual Penalty In BP 100 Amount of Shock Protection (BP) Yr CD at remaining term 5% of Principal Penalty Penalty specified as a percentage of principal is more effective when Rates are low. 32

33 Penalty Effectiveness 5 Yr CD Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 1.50% Penalty Type - (0) Months or (1) % of Principal 1 Penalty Amount - % of Principal 5 Annual Penalty In BP 100 Amount of Shock Protection (BP) 100 Penalty Effectiveness Calculator Original Term (Months) 60 Remaining Term (Months) 60 Offer Rate 5.00% Penalty Type - (0) Months or (1) % of Principal 1 Penalty Amount - % of Principal 5 Annual Penalty In BP 100 Amount of Shock Protection (BP) 100 Protection provided by penalty is independent of rate paid. 33

34 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? High marginal cost! Early withdrawal protection? 34