How to Profit from Your Next Deposit Study
The recent pandemic created the largest amount of excess liquidity in history. The industry has never been more flush with excess cash, loan demand remains weak and margins are now at all-time lows.
Amid this perfect storm, a core deposit study might just be the best yielding investment for your institution today, assuming the information is used strategically. That may be a controversial statement given that most deposit study requests are prefaced with, “Regulators are asking for one.” But think about the current realities outlined above and the opportunity cost of not knowing your deposit base as well as you could.
How might your strategic decisions at ALCO be different if you could gain greater insights into your customer deposit base? Many institutions are debating whether to put “excess” cash to work in the bond portfolio or fixed-rate loans to fortify their earnings stream and help offset 2022 margin pressure. Why the concern? Liquidity risk? Interest rate risk? EVE/NEV? All the above? Regardless of the concerns, the best place to start is by gaining a clear understanding of how “core” your deposits are – specifically the recent surge deposits. This knowledge will bring confidence and serve as a catalyst that leads to optimal cash deployment strategies. Therein lies the powerful return on investment of a deposit analysis.
5 Reasons Why You Should “Invest” in a Deposit Study (Analysis)
Bring Clarity to Surge Deposits. Take your deposit study to the next level by analyzing everything deposit surge. First, quantify the amount of surge on your balance sheet (DCG client average is 18% surge of non-maturity deposits as of 3/31/21). Second, identify the source of surge (consumer vs. business vs. public, balance concentrations, demographics, etc.). The greater clarity in this analysis – the more confidence you will have putting the cash to work.
Gain Confidence in Deploying Cash. We have not seen a material pickup in balance decay through June in our Deposits360°® data analytics platform (analyzing over 225 of our clients’ data). Our predictive model indicates that deposit levels will remain elevated over the next 12 months, even as a portion of the stimulus and PPP surge leaves. Shifting cash into holding mortgage loans or investments can provide a healthy spread relative to staying in cash.
Defend Your Loan Strategy. There is an elevated focus on interest rate risk as institutions have added duration in the loan portfolio. Some institutions have increased the amount of fixed-rate mortgages in the portfolio and there is greater commercial loan demand on 7-10 year structures. However, the asset extension is telling just one side of the story and ignores the underlying funding source, namely core deposits. Tell your side of the story and demonstrate how you fund longer-term assets (hint: identify non-rate sensitive, core funding levels). You may be surprised to find that you have even more long-term funding to support additional asset extension.
Defend Your Interest Rate Risk Position. Interest Rate Risk (IRR) positions have changed materially over the past 15 months. A change strictly due to the deposit surge inflating the cash position – even at a time when loan portfolios have been extending. ALCOs are asking, is the sensitivity change temporary or more permanent?
Once you bring clarity to the deposit surge (see section 1), you should apply alternative IRR simulations to test how sensitivity may change given deposit runoff. For example, we have a client that runs historically liability sensitive (pre-COVID). Today, they are asset sensitive. The client identified about 10% of their non-maturity deposit base to be considered volatile, then ran an alternative simulation showing the deposit runoff reducing cash. They flipped back to a liability-sensitive profile; however, their assumed exposure is less than pre-COVID levels. The analysis gave them confidence on their risk profile and strategy on putting cash to work.
The IRR sensitivity may be more critical for credit unions regarding the NEV Supervisory Test. Most NEV Supervisory Tests are not at risk today given the low-rate environment. However, this might be the calm before the storm when the yield curve eventually steepens. Duration is building and net worth ratios are lower (strictly from the deposit surge) – culminating in elevated NEV Supervisory Test risk. Non-maturity deposit premiums are pre-defined and the same for every credit union in the NEV Supervisory Test. In any circumstance, tell your “core” deposit story. Quantify and defend your non-maturity deposit assumptions for your NII and EVE/NEV models ahead of potential regulatory pressure.
Prepare for the Next Cycle. It is a best practice to analyze deposit sensitivities after a tightening cycle. What did you learn from the last rising rate environment? What worked well and what would you do differently? What will be your first product or pricing move? How much can you lag this time around? Will you focus on CD promotions? What terms? MMDAs? At what point in the cycle for each? Planning now will help answer these questions and optimize growth while managing cost of funds.
A core deposit study should not be a check-the-box exercise. The strategic core deposit study requires the combination of robust institution-specific data combined with industry analysis, forecasting capabilities, and actionable intelligence. We are coming out of an unprecedented deposit surge cycle, and no one knows how this will play out. Analyze your deposit data and tell your story. Many happy returns!
Learn more about DCG's Deposits360°® web-based data analytics solution.
ABOUT THE AUTHOR
Joe Kennerson is a Managing Director at Darling Consulting Group. In this capacity, he works directly with financial institutions by providing solutions for their asset liability management process in the areas of interest rate risk, liquidity risk management, ALM modeling, regulatory compliance and executive-level education. He is a frequent speaker and author and directly advises clients in all aspects of ALM.
Contact Joe Kennerson: email@example.com or call at 978-499-8150 to to request a Deposits360°® demo and learn more about our surge analysis.
© 2021 Darling Consulting Group, Inc.