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Non-Maturity Deposits

Amin Mohomed, CPA, Senior Financial AnalystFrank Wilary, Principal

Wilary Winn LLC

September 23, 2014

Topics Covered• Definition• Advantages and disadvantages as a funding source• Beta• Effective maturity• Momentum• Decay• Surge• Core deposit intangible• Examples

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Definition of Non-Maturity Deposits

Deposits provided by credit unions and banks that have no set maturity. These funds can be withdrawn at any time without any advance notice. In the case of credit unions, non-maturity deposits include:• Share Drafts• Regular Shares• Money Market Shares

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Share Drafts

• Checking accounts• Some institutions offer dividend rates on share draft accounts and some

do not• Generally lower rates than regular shares and money market shares• Option to withdraw at any point in time• Additional services offered:

– Bill pay– Checks– ATMs

• Usually have longer average lives than other non-maturity share types

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Regular Shares

• Saving accounts• Offered dividend rates are usually higher than share drafts but lower than

money market accounts• Limit on withdrawals• Limited check writing privileges • Considered slightly less liquid than share drafts• Generally minimum balance requirements• Usually shorter average life than share drafts but longer than money

market accounts

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Money Market Shares

• Generally higher rates offered compared to share drafts and regular shares

• Less liquid than share drafts and regular shares but more liquid than certificates

• Limit on withdrawals• Higher minimum balance requirements• Depositors more sensitive to market interest rates• Lower average lives due to interest rate sensitivity

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Non-Maturity Shares as a Funding Source

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Advantages• Cheap source of funding• Popular products• Member loyalty• Cross selling opportunities• Ability to determine offered

rates• Insured by the NCUA

Disadvantages• Option to withdraw funds at any

time• Sensitive to changes in interest

rates• Marketing and servicing costs• Regulatory costs – Share

Insurance, BSA etc.

Non-maturity Share Assumptions for ALM• Re-pricing beta• Effective maturity• Decay• Surge

Members have continuous and unlimited options to increase or decreasebalances. These options may or may not correlate to market conditions.

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Sources of Non-maturity Deposit AssumptionsHistorical studies of an institution’s past deposit behavior:• NERA (National Economic Research Associates) study• FDICIA 305• Par

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NERA Study• NCUA commissioned study in 2001

• Items covered:– Comprehensive review of literature on valuing non-maturity deposits– Statistical study of credit union deposit behavior– Evaluation of various vendor methodologies– Recommendations for ALM modeling inputs– Implications and guidelines for the NCUA

• Study does not incorporate the effects of the historically low interest rates and the flight to deposits due to the recent financial crisis.

• Actual credit union historical experience is likely different than the published results.

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FDICIA 305• Refers to distribution limits originally proposed in section 305 of the FDIC

Improvement Act of 1991 (FDICIA)• These guidelines were never implemented

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0 - 3 mos 3 - 12 mos 1 - 3 yrs 3 - 5 yrs 5 - 10 yrs Average LifeCommercial DDA 50 0 30 20 0 1.50

Retail DDA 0 0 60 20 20 3.48MMDA 0 50 50 0 0 1.35Savings 0 0 60 20 20 3.51NOW 0 0 60 20 20 3.44

FDICIA 305 Maturity Distribution Limits (%)

Benefits of a Non-Maturity Deposit Study

• Determine institution specific historical member behavior• Effective maturities are usually calculated longer than the regulatory

studies• Ability to calculate account specific assumptions for special account

types such as high rate checking and high balance money market accounts

• Realistic view of projected interest expense and economic value of liabilities in various interest rate shock scenarios

• Allows for back-testing to evaluate assumptions

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Quarterly Share Re-Pricing Comparison to 1 Month LIBOR

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0.00

1.00

2.00

3.00

4.00

5.00

6.00

Share Drafts

Regular Shares

Money Market Shares

1 M Libor

Beta• Indicates the magnitude of change the credit union would likely

make in response to changes in market interest rates• Calculated with a linear regression that compares the change in

the dividend rate to the change in 1 month LIBOR• Calculated Betas are used for the ALM analysis

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Account Type BetaShare Drafts 0.00 ‐ 0.20Regular Shares 0.15 ‐ 0.30Money Market 0.40 ‐ 0.65

Correlation

• A statistical measure of how dividend rates and market interest rates move in relation to each other

• We test correlation between the movement in dividend rate pricing and 5 interest rate indices: 1 month LIBOR, 3 month LIBOR, 6 month LIBOR, 2 year Treasury, and Fed Funds.

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Product Correlation Correlation Correlation CorrelationType Index No Lag 1 mo Lag 3 mo Lag 6 mo Lag

Regular Shares 1 Mo LIBOR 0.90            0.91               0.92              0.83             Regular Shares 3 Mo LIBOR 0.89            0.90               0.90              0.83             Regular Shares 6 Mo LIBOR 0.88            0.88               0.89              0.83             Regular Shares 2 yr TSY 0.89            0.89               0.90              0.89             Regular Shares Fed Funds 0.91            0.92               0.90              0.89             

Effective Maturity• Indicates when the last cash flow for an account type is projected to

occur• Derived from a second regression analysis modeling the spread

between the rate index and deposit rate versus the average balance for the account type

• Calculation of R-squared measures how well changes in average deposit balances are explained by changes in the spread of the deposit rate to the rate index

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R-Squared Effective Final

Maturity (years)

0 10 0.20 8 0.40 6 0.60 4 0.80 2 1.00 0

 

Effective Maturity• Calculation of Effective Maturities

• Effective Maturities from NERA Study

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Account TypeEffective Final Maturity 

(years)Share Drafts 4Regular Shares 4.5Money Market 2

Account TypeEffective Final Maturity 

(years)Share Drafts 7 ‐ 10Regular Shares 5 ‐ 9Money Market 4 ‐ 8

Financial Crisis Impact on Effective Maturity Calculation

• Due to the unprecedented financial crisis, non-maturity deposit balances have increased even though dividend rates were at historical lows

• As a result, longer effective maturities are usually calculated while analyzing non-maturity deposits

• Wilary Winn recommends using 50% to 75% of the calculated effective maturities for ALM modeling in a rising interest rate environment

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Momentum• Rate of acceleration of account balances• Compares current account balance to historical trends• Derived from the results of the effective maturity calculation – Balances

are estimated given the current spread of deposit rate to risk free index• May indicate the presence of surge balances

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Decay AssumptionsA decay rate analysis can be performed using one of two methods:

a) Account number method: This method begins with a set of accounts and balances. These accounts are then tracked in order to determine what happens to the balances over time. In the process, no new accounts are considered.

b) Origination date method: This method compares beginning and ending balances of all accounts by account type and also takes new accounts into consideration in order to determine a decay rate. Account numbers are generally not needed for this method.

In most cases, both methods will yield roughly the same results.

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Decay – NERA Study

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Share Type -300 Base +300Share Drafts 17.00 21.00 24.00Regular Shares 15.00 19.00 22.00Money Markets 37.00 40.00 44.00

NERA Decay Rates

Decay for ALM Analysis

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Share Type -300 -200 -100 Base +100 +200 +300Share Drafts 8.50 9.17 9.83 10.50 11.00 11.50 12.00Regular Shares 10.50 11.17 11.83 12.50 13.00 13.50 14.00Money Markets 18.50 19.00 19.50 20.00 20.67 21.33 22.00

Decay Rates by Shock Scenario

Financial Crisis and Surge Deposits

• As a result of the recent financial crisis, financial institutions experienced non-maturity balances increasing even with dividend rates at historic lows

• Investors increased their preference for liquidity leading to a surge in deposits at financial institutions across the nation

• These Surge deposits are projected to migrate into alternative investments in other asset classes as market interest rates increase

• Surge deposits should be modeled with high decay rates and higher-than-average betas to forecast the outflow of these funds

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Surge AnalysisActual vs. Projected Balance

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20% of the money market balance is identified as surge

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

Actual Balance

Projected Balance

Money Markets - Actual vs Projected Balances

Core Deposit Intangible• Underlying premise is that a rational buyer is willing to pay a premium to

obtain a group of core deposit accounts that are less expensive than the buyer’s marginal cost of funds

• Wilary Winn uses calculated betas, decay rates, and effective maturities in the CDI valuation process

• All-in-costs are estimated using the projected dividend rates paid and net costs to service non-maturity deposit accounts

• All-in-costs are then compared against the buyer’s marginal cost of funds (net borrowing costs) to determine the amount of cost/benefit

• This cost/benefit amount is then discounted in order to calculate the CDI

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Share Premium Example

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Scenario Base +100 +200 +300 +400NERA Assumptions ‐0.90% 0.00% 0.90% 1.75% 2.50%Historical Study Assumptions 2.70% 5.30% 7.50% 9.90% 12.00%Shares at Par 0.00% 0.00% 0.00% 0.00% 0.00%

*Share Premium = 1‐(Fair Value of Shares/Book Value of Shares)

Non‐Maturity Shares Premium*

ALM Position Example

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Scenario Fair Value of Assets

Fair Value of Liabilities

Fair Value of Equity

% Change from Base

NCUA Risk Level

-300 220,965,000 204,115,000 16,850,000 7.71% Low-200 221,385,000 204,287,000 17,098,000 9.29% Low-100 219,778,000 202,537,000 17,241,000 10.21% LowBase 215,501,000 199,857,000 15,644,000100 209,383,000 196,077,000 13,306,000 -14.95% Low200 204,047,000 192,494,000 11,553,000 -26.15% Moderate300 198,914,000 189,092,000 9,822,000 -37.22% Moderate400 193,309,000 185,860,000 7,449,000 -52.38% High

Historical Study Non Maturity Deposit Assumptions

ALM Position Example

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Scenario Fair Value of Assets

Fair Value of Liabilities

Fair Value of Equity

% Change from Base

NCUA Risk Level

-300 220,965,000 203,789,000 17,176,000 30.95% Moderate-200 221,385,000 203,878,000 17,507,000 33.48% Moderate-100 219,778,000 203,671,000 16,107,000 22.80% LowBase 215,501,000 202,385,000 13,116,000100 209,383,000 199,783,000 9,600,000 -26.81% Moderate200 204,047,000 197,277,000 6,770,000 -48.38% Moderate300 198,914,000 194,862,000 4,052,000 -69.11% High400 193,309,000 192,534,000 775,000 -94.09% High

NERA Non Maturity Deposit Assumptions

CU Philosophy and Share Pricing

• Credit unions are member-owned and seek ways to maximize member benefit

• Member benefits can be provided by:– Above-market dividend rates– Affordable loan rates– Other products – mobile banking, drive-thru ATMs etc.

• Providing above-market dividend rates on non-maturity deposits is possible given the institution has the required level of capital to sustain these rates

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Capital and Share Pricing

• Share pricing is based on a variety of factors including the level of capital

• Currently credit unions usually provide above market dividend rates, given the required level of capital to sustain these share prices

• The primary risk here is to maintain the current level of capital in an increasing interest rate environment

• These above-market dividend rates also need to be incorporated into the ALM process

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Non-Maturity Deposit Studies

• Credit unions can analyze non-maturity deposit behavior using account level information or the 5300 call report data

• An account level analysis is more extensive and can be customized based on account type characteristics

• Important information may be missed while analyzing non-maturity deposit behavior using call report data

– Inability to analyze deposits by tier– Inability to calculate historical decay rates due to lack of information– Inability to segregate information based on different account characteristics on

accounts grouped within the same call report account type

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Recommendations

• In the ALM modeling process, the equity position should be analyzed under three different scenarios:

– Institution specific non-maturity deposit assumptions– NERA/FIDICIA 305 non-maturity deposit assumptions– Non-maturity deposits at par

• Non-maturity deposit data should be analyzed over the last 10 years in order to include the effects of different interest rate environments

• Surge deposits should be identified and run-off faster than normal deposits

• 50% - 75% of calculated effective maturities should be used• Back-testing of non-maturity deposit assumptions

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Contact Information

Wilary Winn LLCFirst National Bank Building

332 Minnesota Street, Suite 1750WSaint Paul, MN 55101

651-224-1200

www.wilwinn.com

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Services and Contact Information

Private Label MBS/CMOs and Asset Liability Management:Frank Wilary fwilary@wilwinn.com

Mergers and Acquisitions, Fair Value Footnotes, ASC 310-30, and TDRs:Brenda Lidke blidke@wilwinn.com

Mortgage Servicing Rights and Mortgage Banking Derivatives:Eric Nokken enokken@wilwinn.com

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