How to Profit from Your Next Deposit Study

Sponsored by Darling Consulting Group

The pandemic created the largest amount of excess liquidity in history. The credit union 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 credit union 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 your next asset/liability committee meeting be different if you could gain greater insights into your member deposit base? Many credit unions 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? Net economic value? 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 to ‘Invest’ in a Deposit Study

1. Bring clarity to surge deposits. Take your deposit study to the next level by analyzing everything related to your deposit surge. First, quantify the amount of surge on your balance sheet. (The DCG client average is 18% surge of non-maturity deposits as of March 31, 2021). Second, identify the source of the surge (consumer vs. business, balance concentrations, demographics, etc.). The greater the clarity in this analysis, the more confidence you will have to put the cash to work.

2. Gain confidence in deploying cash. We have not seen a material pickup in balance decay through June in our Deposits360°® data analytics platform, which analyzes the data of more than 225 of our clients. Our predictive model indicates that deposit levels will remain elevated over the next 12 months, even as a portion of the stimulus and Paycheck Protection Program surges leaves. Shifting cash into mortgage-backed securities with an average life of five to eight years can earn a spread of 100-150 basis points.

3. Defend your mortgage strategy. There is certainly an elevated focus on interest rate risk as the industry has undergone a loan mix shift from shorter-term products (auto and home equity) into mortgages. We are hearing that mortgage-related concentration limits have been a hot topic in recent exams. However, the mortgage concentration tells 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.

4. Defend your interest rate risk position (and 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. Therefore, it is critical that you quantify and defend your non-maturity deposit assumptions ahead of potential regulatory pressure. 

5. 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? Money market deposit accounts? 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. 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! 

Joe Kennerson is a managing director at Darling Consulting Group, a CUES Supplier member based in Newburyport, Massachusetts. Kennerson works directly with senior management teams on building customized balance sheet strategies to improve earnings and manage risk. He strives to be an expert in overall asset/liability management and educates asset/liability committees in the inevitable balance of financial performance and regulatory appeasement. He is a frequent speaker on ALM topics and strives to make the complex simple while bringing a high level of energy to his sessions. Kennerson has been with DCG since 2005, where he has benefited from working with nearly a thousand ALCOs throughout the country on ALM and strategic initiatives. A graduate of University of New Hampshire with a degree in finance, he lives in Boxford, Massachusetts, with his wife and two children and has been an active member with the Big Brothers Big Sisters program.