The Cash Conundrum
Deposits | ALM Strategy | Liquidity
"What do I do with all this cash?” is the question that keeps most bankers awake at night. Deposit growth has not slowed and, oddly, bankers are looking to shed deposits rather than grow them. The prospect of another stimulus package and PPP loan forgiveness could result in even higher cash levels. Putting cash to work in the lowest rate environment ever is no easy task, yet we must get buy-in from our stakeholders. First, quantify your margin pressure this year. Margins will fall for most if rates stay low – and putting a number to this downward trend helps identify if there is a level of urgency to redeploy cash. We should be able to answer this question with our ALM model.
Second, forecast deposit expectations. Although extremely challenging, forecasting potential deposit outcomes can be addressed with a little digging and some data analysis. We have found the inability to articulate the deposit outlook may hinder the ability to convince stakeholders that we should be redeploying excess cash.
1. Quantify Surge
Looking back at 2020, what was your expected deposit growth target and where did you end up? Through our Deposits360°® analytics, it would not be unusual to see non-maturity deposit surge in the ballpark of 15%. Breakdown the attribution to PPP, consumer, business, and public funds. Go a layer deeper into understanding how much growth came from new accounts vs. existing accounts. The goal is to gather as much intel as possible.
2. Forecast Potential Outcomes
Forecasting is the trickiest part of the exercise. Start by compartmentalizing by vintage. A DCG colleague has coined the term, “a balance sheet within a balance sheet.” First, the surge component. There are many opinions on how consumer spending may accelerate as the vaccine is administered (and thus the impact on deposit balances), but no one knows for sure. Run multiple iterations of surge runoff through appropriate time periods. Second, most institutions would expect their core balance sheet to see growth during a low rate environment. The combination of these two factors can provide a range of potential outcomes which may help bring clarity to potential cash expectations.
3. Forecast Potential Outcomes
Forecasting is the trickiest part of the exercise. Start by compartmentalizing by vintage. A DCG colleague has coined the term, “a balance sheet within a balance sheet.” First, the surge component. There are many opinions on how consumer spending may accelerate as the vaccine is administered (and thus the impact on deposit balances), but no one knows for sure. Run multiple iterations of surge runoff through appropriate time periods. Second, most institutions would expect their core balance sheet to see growth during a low rate environment. The combination of these two factors can provide a range of potential outcomes which may help bring clarity to potential cash expectations.
4. Track Activity
For most balance sheets, deposits are still very sticky (we still see negative decay for many non-maturity deposit books). However, this could turn quickly. Track specific cohorts to establish early warning systems of a potential deposit run. Also, what have you learned since the big deposit surge in April? One data point that we noticed is new accounts opened in April subsequently decayed at a much faster pace than existing accounts. Our analytics suggest accelerated runoff over the first 6-12 months in new accounts relative to existing accounts. How does your on-boarding strategy nurture these new accounts? Our clients experienced greater than normal new account openings in 2020 – suggesting now is an opportune time to expand your customer relationships. Do not let the surge in deposits impact your focus of growing and expanding core deposit relationships.
5. Test Elasticity
It is hard to continue to "beat the drum" on lowering deposit rates. However, our Deposits360°® analytics show there is a negligible difference in balance decay trends for the lowest paid vs. highest paid MMDAs in our client data set. In other words, rate seems to have little impact on deposit stability. Lowering 10 bps on MMDAs may have a small dollar impact for each customer, but at the portfolio level can provide meaningful NII relief and limit the amount of cash extension needed to fill the NII gap.
The great deposit surge of 2020 has left the industry with too much cash yielding next to nothing. Bring clarity to your deposit story to help accelerate your strategy to offset potential margin pressure in 2021.
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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: jkennerson@darlingconsulting.com or call at 978-499-8150 to learn how our clients are utilizing Deposits360°® to forecast out surge outcomes.
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