Core Deposits 2013

2013 AMIfs annual conference

Orlando FL, April 24, 2013

Fred Poorman Jr., CFA, Managing Principal

fpoorman@bankriskadvisors.com

Claudina Tesouro, Director

ctesouro.com@bankriskadvisors.com

1

A tale of two banks:

transfer pricing and

valuing assets &

liabilities

session is interactive:

please ask questions

and/or comment on

practices at your bank

Session overview

• Rising regulatory requirements & other changes

• Bank 1: story of a community bank core

deposit analysis & systems upgrade

• Bank 2: story of a large bank upgrading systems

& methodologies (on another SlideShare

presentation)

• Review recent survey results & industry trends in

FTP & ALM (on another SlideShare presentation

2

We can all agree that It seems that regulatory guidance is ongoing;

consider the number of OCC Bulletins issued

• source: occ.treas.gov

3

We can all agree that: It seems that regulatory guidance is also

changing. Changes to existing guidance is

almost as numerous as new guidance.

• source: occ.treas.gov

4

What has happened:

Changes written by

David Bowie

Result is regulatory

requests for more robust

(i.e. expensive) systems

and more complex and

comprehensive

methodologies

Changes: “Every time I thought I'd got it made”

• Regulatory guidance grew & changed

o previous slides

• Analytical processes became more sophisticated

o stress testing & reverse stress testing

o scenario, sensitivity, and extreme event

analysis

o slides forthcoming

• Products became more complex

o products are more complex (e.g. CDOs3)

o awareness of product complexity is more

prevalent; for example MMDAs are seen

as an exotic option with implicit bank and

customer options

5

Background:

Ken, the Treasurer,

“explained” that his bank

management did not

value Core (non-

maturity) Deposits and

focused on the lowest

cost CD funding,

including wholesale and

brokered CDs.

He wondered if there

implications where any

implications for FTP,

ALM Modeling, and

Liquidity?

Bank 1: story of a community bank and core

deposits analysis

• Ken also told us that his bank used the old OTS

decay tables for FTP & ALM as “required” by their

OTS examiners.

• OTS MMDA decay:

o 32% year 1

o 37% years 2-3

this means 50% of accounts run off in

2 years!

could anyone stay in business if

this were true?

this is not even reasonable

o 17% years 3-5 , 12% years 6-10

2% of accounts are left after 10

years?

6

bank used old OTS

decay table

did this result in

profitable and value

additive behaviors?

Bank 1: what do OTS assumptions mean?

• MMDAs were transfer priced as a 2+ yr. average

life product that was a “break-even” product after

consideration of accounting servicing expenses

and fees

• MMDAs were priced around par for Economic

Value purposes

• No incentive to originate MMDAs from profitability

system or franchise (or economic) value

perspective

• CDs were used and are easier to book and

cheaper to maintain

7

the Weibull distribution is

named for Waloddi

Weibull based on his

1951 paper “A Statistical

Distribution Function of

Wide Applicability”

widely used for survival

(retention) analysis,

reliability/hazard

analysis, and root cause

analysis

we recommend The

Weibull Analysis

Handbook, Dodson, B.

(2002)

Core Deposits as a risk management tool:

A new approach to analyzing Core Deposits

• retention (survival) analysis using Weibull

distribution

o Standard statistics use central tendency

and variance as descriptors

o Weibull statistics use central tendency,

variance, and shape as descriptors

• focuses on behaviors of deposit products and

vintages (year account opened) like MBS

• provides account sensitivity parameters at

deposit product and vintage level

• these analytics readily provide replication for

FTP, ALM modeling, and hedging

• provides a mathematically valid projection of a

loss in deposits/change in average lives should

market rates change and bank holds rates

constant

8

developed by Howard Stern, PhD and Fred:

• Howard was a Finance professor turned into a banker then a Wall Street MBS/CMO quant

• Fred was a banker then Wall Street Fixed Income Research Manager morphed into a salesperson and then a fixed income fund designer

Vintage analysis is essential for MBS analytics, vintages were previously only used for back-testing in published core deposit research

Bank 1: Vintage survival curves

10

Ken and the bank’s team

came to understand that

different vintage (date of

origin) products behaved

differently, much like

loans.

This is likely due to

product design, pricing,

and marketing as well as

other internal product

pricing and external

market forces. Root

cause analysis would

quantify these impacts.

Bank 1: retention (survival) analysis using

Weibull distribution, different vintages

11

Illustrates that the Bank should raise deposit rates when market rates move or they will lose lots of deposits

Differentiator between us and others: this is the only core deposit analysis product that estimates the impact of this critical decision by ALCO

This approach is mathematically accurate, however rates have remained unchanged since publication

Changes in average lives due to holding rates

constant when market moves

12

What happened? Bank 1: Changes in FTP and incentives

• Both insured and uninsured MMDAs had much

longer lives than OTS assumptions

• Changes in FTP methodology to match new

behavioral analysis

o MMDAs were now profitable under new

FTP methodology and inputs

o Other Core (non-maturity) Deposit

products were very profitable

o Above is true as yield curves are usually

upward sloping

• Team members are incented to grow Core

Deposits

• Bank understands profits coming from sub-

Wholesale Funding rates, not just CRE loans &

mismatch risk

13

What happened?

Bank MMDA average

lives changed from 2.4

years to 7.0 to 10.5 yrs.

Overall, Core Deposit

average lives went from

2.7 to 10.6 years

Bank 1: Changes in ALM & franchise value

• Recognized significant profit and economic value

increases from Core Deposits

• De-emphasized CDs, especially Brokered and

Wholesale, and refocused on Core Deposits

• Additional profitability from selective loan

extension

• Better understanding of core behaviors (average

vs. older & recent vintages…prepayment

analogy)

o Different assumptions for existing and

new book of business

• Increased franchise value, EVE, EVE sensitivity

• More stable funding and better liquidity ratios,

especially Basel II/III Net Stable Funding (NSF)

ratio, where Core Deposits are the numerator

14