The Newest Surge: Deposits
2008 Throwback or Temporary Growth
The COVID-19 situation, currently termed “the Great Lockdown,” has created a unique operating environment for institutions of all sizes. Deposit growth is currently outpacing loan demand in the industry, leaving many ALCO’s re-evaluating pricing and liquidity strategies as we approach the mid-year mark.
Recent headlines announced that the personal savings rate balances in the U.S. almost doubled in one month from $1.3 trillion in February to $2.2 trillion in March. Deposits at commercial banks have increased over $1.5 trillion since the start of the pandemic. The combination of unprecedented governmental response and stimulus—coupled with reduced consumer spending driven by both fear and national-stay-at-home orders—have pushed the personal savings rate to the highest levels we have seen in over 30 years. Most consumers have rightly bolstered their personal liquidity position to deal with a situation our great-grandchildren will most certainly study in their U.S. history classes in the years to come.
From the Editor
With Memorial Day upon us, thank you to all current and past military members and their families for your service to our country, as well as everyone on the frontlines battling COVID-19. We are all in your debt!
It has been a while since we have quoted Yogi Berra in the DCG Bulletin, but it feels like a good time to break out a famous one, “It's like déjà vu all over again.” The changes in our everyday lives can make things feel this way, but also with what is happening to our balance sheets. In this month’s Bulletin, Justin Bakst discusses how some trends seem to be repeating themselves, while offering insight into how to utilize data to improve deposit strategy going forward.
Please continue to be safe, and to send comments, questions, and ideas for future articles.
Keith Reagan, Executive Managing Director
Questions remain, including how will depositors behave once America is fully reopened for business? Will banks continue to see a surge in deposits or will spending erupt as the country stabilizes? Regardless of the long-term outlook, best-in-class institutions have recognized that today’s unusual banking environment may take a turn for the worse before conditions improve, specifically the impact on net interest margin and earnings levels. These institutions are already managing their deposit base to reflect this new norm with aggressive pricing strategies. Would your deposit pricing strategy change today if you knew there was a greater probability of a non-maturity deposit surge in the next 12-18 months? Let’s learn from history and potentially look into the future to help develop strategies to contain margin pressure.
Back in Time
Succeeding the financial crisis, community institutions experienced significant growth in non-maturity deposits. From the Q4 2008 to 2015, the average annual growth rate in non-maturity deposits was 13.5% compared with 7% the prior 16 years. During this same period of time, total deposits grew 5%. This growth in non-maturity deposits was termed by many in the industry as “deposit surge.” This surge was driven primarily by insufficient alternatives for customers, including ultra-low time deposit rates and bond yields as well as reallocation out of alternative assets. In essence, rate levels and uncertainty about the future drove customers into non-maturity deposits. History has a funny way of repeating itself; many experts believe we could be in for another period of prolonged low interest rates and uncertainty.
Forecasting Deposit Behavior
As Yogi Berra famously said, “It’s tough to make predictions, especially about the future.” As risk managers, it is our responsibility not to bet on any one specific outcome but to instead forecast and quantify potential outcomes, triangulate risks, and make informed strategic balance sheet management decisions. Yet how does one quantify which outcomes are possible or most likely to occur?
In this spirit, DCG—and specifically my colleague Dr. Jonathon Weiner—has developed a deposit forecasting model that can help predict which outcomes are more probable. By analyzing observed historical deposit behaviors, the model evaluates how non-maturity deposit growth is affected by deposit pricing, risk-free interest rates, as well as account balance and age. This multi-factor regression model was calibrated against a dataset of over two billion records, spanning two decades, and covering 48 states and 5,000 branches.
As of March 31, 2020, the model is predicting that banks and credit unions will experience a surge in non-maturity deposits over the next few quarters as rates head toward zero. The driving force behind the model results is the reduced availability of higher-yielding investment opportunities. As CD and bond yields drop, there is less incentive to keep cash tied up in these alternatives and insured non-maturity deposit accounts are positioned to become a primary destination.
According to the model, lowering deposits rates will have only small downward pressure on balance growth trajectory. The trade-off or sensitivity to pricing and the relationship between pricing and balance decay can provide institutions the confidence to make swifter and more aggressive pricing decisions and combat margin pressure. Let’s not fall victim to the previous falling rate cycle when it took years for deposit rates to price down to wholesale levels—a time in which longer-term Treasury rates were 2% higher than what we are facing today.
Deposit Pricing Roadmap
Institutions are simultaneously contemplating the potential for a surge in non-maturity deposits while managing an uncertain liquidity position. In this vein, institutions are searching for a road map to navigate this environment and price deposits accordingly. According to DCG’s Deposits360°® Cross Institution database, over the next 90 days we anticipate a wave of time deposits maturing with rates 100-250 basis points above current prevailing rates. In addition, a surprising amount of institutions are paying significantly above prevailing market rates in premium money market accounts. Every basis point of reduction is material in an environment of shrinking margins and increased risk. There is tremendous opportunity to reposition and lower time deposits in the short term that financial institutions need to take advantage of. Any misstep can have a meaningful impact on margin.
As banks have moved rates downward, we have found little customer pushback with few exceptions. Interestingly, it is not uncommon to see some financial institutions reduce rates to all-time lows—with little impact on volumes. The value proposition of accounts in this environment has less to do with rate paid and more to do with the nature of the relationship with the institution and the safety and security provided. Customers fundamentally understand that rates paid on deposits have to decrease regardless of the account type. At the same time, we don’t suggest recklessly slashing rates. Institutions need to determine their most strategic course of action, and we have found the most successful organizations are using data and analytics to better understand the deposit base before taking action.
Managing and Monitoring
Segmenting the deposit base is the most effective way to project how customers may react to significantly lower interest rates. These analytics range in sophistication from demographic, peer and econometric models, to simple back-of-the-envelope spreadsheets. Some institutions are segmenting their deposit base between rate shoppers and negotiated rates, core customers and those who fall somewhere in the middle. Institutions are using analytics and segmentation—looking at the history of the relationship, number of accounts, and size of relationship—and even analyzing time series data sets to understand the rate and pace of declining balances in order to identify at risk customers.
Deposit pricing is both an art and a science. Our recommendation is for institutions to be aggressive with rate reductions but sensitive to customers’ needs. Unfortunately, without strong client relationships and/or informative analytics, it becomes very challenging to understand and appreciate customer needs.
Liquidity Needs
During the very initial stages of “the Great Lockdown” many institutions were deeply concerned about their longer-term contingency funding plan. The combination of several factors—including large cash withdrawals, business deposit uncertainty, municipality concerns, and lower bond collateral values (to just name a few)—partially triggered this anxiety. The Federal Reserve has helped ease some of these issues with an unprecedented response, including broader access to various liquidity channels. As concerns have eased, more stability does exist. This isn’t the time for intuitions to become complacent with their liquidity position, however. Deposit strategy should fit into the cost benefit analysis of the total liquidity position. Regardless of DCG’s forecasting model, a deposit surge is not a forgone conclusion by any stretch of the imagination. We could paint the picture of a double dip economic shock creating more fear, more uncertainty, and potentially difficult liquidity conditions.
How do we balance the contradictory nature of potential deposit surge against a concerning liquidity environment? We believe deposit strategies should be holistically aligned with broader balance sheet management and funding strategies. To specifically address deposit behavior, we are advising clients to create more robust early-warning liquidity triggers or key performance indicators and to run COVID-19 specific scenarios as part of their contingency plan. One key assumption in this analysis is the existence of at-risk deposits. This time series data, analyzing the rate and pace of declining balances, does not only inform pricing but also serves as a key input into liquidity funding plans.
Taking Action
Yogi Berra also famously said, “The future ain’t what it used to be.” While many may nod their heads in agreement, the uncertainty thrust upon us should not prevent us from formulating disciplined, thoughtful, and strategic action plans. Although the coming months will create a very challenging environment for bankers, we will rise to the occasion as we have successfully done thus far and continue to credibly serve our communities during this crisis. Every basis point counts today more than ever before. Utilizing tools in our toolkit, including robust analytics and a total liquidity approach, can help us more efficiently and effectively manage our deposit base.
Learn more about DCG’s Deposits360°® solution.
ABOUT THE AUTHOR
Justin Bakst is a Managing Director at Darling Consulting Group. Justin provides risk management education and strategic consultation to financial institutions leveraging DCG’s analytics solutions. Justin has been a thought leader in risk management including interest risk, credit risk, and liquidity risk. Justin is a frequent speaker and author with the RMA, American Banker, NYTimes, and CIOMagazine.
© 2021 Darling Consulting Group, Inc.
