Lecture Materials FUNDING - Madison · –Cannibalization assumptions –New money assumptions • But our capital plan has us growing deposits. How about some offensive strategies?

Lecture Materials

FUNDING

Thomas A. Farin Chairman of the Board

FARIN Financial Risk Management Fitchburg, Wisconsin

[email protected] 608-661-4219

August 7 & 8, 2017

CREATE SYNERGY. DRIVE PROFITABILITY

Session 1

1

Funding - Developing Funding StrategiesGeneral Requirements & CDs


Liquidity & Funding Management Goals

• Liquidity Management– Managing cash flows across

the balance sheet to ensure sufficient sources of funds for intended uses of funds.

– Sets limits on • Liquid asset levels• Acceptable mismatches• Use of alternative (wholesale)

sources– Refers to (in-)ability to raise

sufficient funds to finance needs at any point in time.

• Funding Management– Defined as the process of

sourcing liabilities– Sets forth how you intend to

remain fully funded at the minimum cost consistent with the overall risk appetite.

– Balances cost efficiency and stability.

– Outlines targeted funding mix impact on operating and funding cost stability

– Refers to the (in-)ability raise funds in the desired type/term/cost on an ongoingbasis

2


Pre-Session Agenda• Sources of Funding?

– Retail Funding– Wholesale Funding– Capital

• What are the Goals of a Funding Strategy?

• Metrics for Analyzing Deposit Behavior– Pricing Betas– Pricing Lags– Decay Rates– Surge Balances– Benchmarks

• Analytic Tools for decision making– Average Cost– Marginal Cost

• Deposit Strategies– Depositor Segmentation

3


Remainder of Funding Section• Attend three lectures that build a foundation• Apply the concepts taught in the pre-session• Attend a two session lab in which you will

become familiar with the tools used in the intersession project and get a running start.

• Produce an intersession project in which you develop a funding strategy for at least one deposit sector.

• Ideally present your strategy to senior management

4


Retail Funding StrategyGoals

– Keep the bank fully funded –liquidity needs

– Minimize the cost of funding the bank

– Use retail & wholesale funding effectively

– While• Hedging interest rate risk• Using funding that is stable• Living within policy (and

regulatory) guidelines

Funding Strategy Inputs– Performance analysis– Market share trends– Capital Plan– Your current deposit structure

and pricing– How you stack up relative to the

competition.

• Funding Strategy Outputs– Growth goals.– Deposit sector and subsector

targets– Pricing strategy

• Segmentation• Pricing rules

5


We Divide Deposits into Four Sectors

• Checking – All of your full-service checking accounts– Business– Personal

• Savings and Money Markets – where you customers park short-term liquidity– Savings accounts– Money Market Accounts

• Short-Term CDs (0-15 Mo)– 0-4 Mo– 5-9 Mo– 10-15 Mo

• Long-Term CDS (>15 Mo)– 16-29 Mo– 30-40 Mo– 41-53 Mo– 54 Mo

6


What Would You Need to Know• Trends in your

performance relative to peers (BPA)

• Trends in Market Share• Capital Plan

• At Sector Level– Current Deposits and Rates– Competitor Rates– Current Sector Pricing Rule

• Pricing Strategies• Recommended Pricing

Rule

7


BPA Ratios - Most Important to Funding Strategy

• ROE– Top of tree– Organic Capital Growth Rate (net

of Dividends)

• ROA– Second Level at top of tree– Input to capital planning model

• Equity Multiplier– Inverse of capital ratio– Setting capital goals– Input to capital model

• Loan/asset or loan/deposit ratio– Do we want to grow deposits

faster or slower than assets?

• Cost of funds trends and relative to peer– Major factor in net interest margin– Major factor in gain or loss of

market share

• Deposit mix, trends, relative to peer– How are you funding yourself– Do you have significant CD

surges?– Why is cost of funds above or

below peer?8


What if you saw?

9

UnderperformsRelative to peer.Why???

Peers are improving, they aren’t – why???


One of the Issues is Loan Mix

10

But it is not deposit cost – 43bp vs 57 bp peers.Have gone from over peers to under peers


Trends in Deposit Mix

11

Are surge balances continuing to develop?

CDs

NMDs


Deposit Mix vs. Peers

12

NMDs

BrokeredDeposits

How do you feel about this strategy? Is what you see consistent with a cost offunds below peers?


Does this make sense?

13

Non-maturity deposits have an average cost below CDs.• But we have less of them than peersBrokered CDs have a high average cost• But we have more of them than peersYet our average cost of funds is below peers

Anyone have any theories as to why this is happening?


Is this – Consistent with this?

14

Above Competition At or Below


Capital Planning• Trend

Analysis looks back in time

• Capital plans look forward.

15

C/A = 1/EM = 1/8.79 = 11.37%

Capital plan limits asset growth to 3% per year. But given the high brokeredfunds position, deposit growth goals could be higher to displace brokered. Let’ssay we set our deposit growth goal to 5-7% per year.


DEVELOPING A FUNDING STRATEGY FOR SHORT-TERM CDS

16


Deposit Audit – ST CDs

17

ABC Bank offers 3 terms of short-term CDs, 3 Mo, 6 Mo, and 1 Yr. They are nottiered. They have not offered CD specials in some time. Balances have declinedIn the last 5 years.


Survey Data

18

Current pricing rule: Price regularCDs at or near the bottom of the market based on survey data. Notcurrently running specials.


ST CD – Pay Up

19

Accounts, rates, and maturities are from the deposit audit.I am going to evaluate these two strategies in a 200 bp rising rate environment.After the fed has raised rates 75 bp with no significant response from competitorsbecause of the lag between wholesale and retail rate increases. So I’m really onlytaking benchmark rates up another 125 bp. Because CD betas are around 1.0 (100%) I’m taking CD rates in Strategy 1 up by 2% (the full market rate increase).


ST CD – Pay Up

20

CDs have been declining as a percentage of funding as a result of the current pricing strategy. Looks to be around 10% in 2016. So I’m going to assume that a continuation of the existing pricing strategy will cost us 10% of balances in the nextyear, strategy 1.


Lags between wholesale rates and deposit rates through two rate cycles –national data

CD rates show a strong correlation to movements in Treasury rates but lag 3-6 months behind Treasury movements. So far in the last year the Fedhas raised rates 75 bp with no competitive rate reaction. So we are in a lag period.

Rising Rate Lag

Falling Rate Lag

21


ST CD – Pay Up

22

FHLB DM

I assumed in strategy 1 we would retain 90% of maturing funds based on history.I accomplished this by typing formulas in Column F that set the retention at 90%. Ialso entered a benchmark rate in F22. As market rates are already up by 75 bp,They had only 125 bp to go to hit the market rate increase of 200 bp. So I took the 9 month advance rate and added 125 bp to get the benchmark of 2.74%

+ 1.25%


CD – Pay Up - Defensive

23

To hold onto all maturing funds,I figure I would have to priceSomewhere between the 50th and 75th percentile of competitors. TheArrows indicate where I felt I wouldHave to price. Keep in mind, I have to pay attention to competitor specials.


ST CD – Pay Up - Defensive

24

Average cost fans – doesn’t look too bad. Average cost of strategy 2 is 34 bp underthe benchmark. But average cost fails to capture the cost of paying up on existingfunds to attract new funds. Marginal cost is equal to the change in expense dividedby the change in balances. $43 thousand in additional expense on $1 million in additional balances is a marginal cost of 4.34%, 160 bp over benchmark.Marginal cost is 4.34% while average cost is 2.41%


Sources of Funding• Retail Funding

– Generally – Deposits gathered from customers

– Types• Non-Maturity Deposits• CDs

– Popular With regulators– Cost of funds can be below

wholesale alternatives– When you want more you

often pay up on existing funds to attract new funds

– Segmentation techniques can work here

• Wholesale Funding– Generally, funds gathered

from non-customers– Examples

• FHLB Advances, Brokered CDs, Fed Funds, etc.

– Not as popular with regulators– Cost of funds at or above

Treasury rates– When you want more you

pay the market rate– Segmentation techniques

don’t work here

25

Do you understand why our case bank may have decided to fund with Brokered CDs rather than customer CDs … and how average cost of funds could be lower?


ST CD - Defensive Segmentation

26

In this segmentation strategy rates on regular CDs were raised using a beta of 0.75.But a 13 month CD special was introduced at a rate that matched the top rate paidon 12 month CDs in the pay up strategy. Over 50% of the funds switched to thespecial. Marginal cost of the $1 million retained was 1.44%, 130 bp under benchmark.Why was the marginal cost below the rate paid on the special? Enough was saved onthe non-rate sensitive customers to cover the amount paid up on the money that shiftedplus a portion of the cost of the $1 million.


Conclusions from Defensive Testing• A CD segmentation strategy properly and

consistently tested will almost always result in a a lower marginal cost than a ‘pay up’ strategy.

• If some of the assumptions being made trouble you, do a sensitivity test on those assumptions.– Rate assumptions– Cannibalization assumptions– New money assumptions

• But our capital plan has us growing deposits. How about some offensive strategies? Let’s say our goal is to grow ST CDs by 5% - consistent with our capital plan.

27


CD – Pay Up - Offensive

28

To grow ST CDs pricing will have toBe at or near the top of the market.


ST CD - Offensive Segmentation

29

Rate increased to top of market (2.8%). Balances in sector grow by 5%. Marginal cost is 21 bp over benchmark. Can we do better?


Barrier to Entry Strategies - CDs

• Segmentation strategies incorporating barriers to entry:– Minimum balance requirements– Tiering– Geographic segmentation– New money specials– Relationship pricing

ExistingCustomers -less than 100% cannibalization

New customersand new money

Barrier Strategy

30


ST CD - Off Seg - Tiered Barrier

31

Rate increased to top of market in upper tier (2.8%). Balances in sector grow by 3%. Marginal cost is 37 bp below benchmark. Why does this work?


ST CD - Off Seg – Geographic

32

CD Special priced defensively in market A, offensively in market B (3.0%). Balances in sector grow by 11%. Marginal cost is 4 bp below benchmark. Why does this work?


Long-Term CDs• Segmentation strategies are similar to those

with short-term CDs except:–There may be more sleepy money (less

cannibalization).–Segmentation strategies take longer to have an

effect• Lower CD turnover because of laddered term structure.• Generally a lower percentage of funding.• Issues relating to effectiveness of early withdrawal penalties.

–Generally I recommend:• Avoiding aggressively pricing CDS of 36 months or more, which

means keep your specials relatively short.

33


Penalty Effectiveness – 5 Yr CD

34

5 Yr CD atoriginal term

12 Mo Penalty

Penalty Effectiveness CalculatorOriginal Term (Months) 60Remaining Term (Months) 60Offer Rate 1.50%Penalty Type - (0) Months or (1) % of Principal 0Penalty Amount - Months 12 Annual Penalty In BP 30 Amount of Shock Protection (BP) 30

If long-term rates go up more than 30 bp, customer’s earlywithdrawal option goes in the money.



35


24 Mo Penalty

Doubling the penalty doubles the protection. But is it enough?




36


24 Mo Penalty

Penalties of days interest are much more effective when rates go up.But it is when rates are low that we need the penalty the most.And when rates are up, we remain need them the least.





37


24 Mo Penalty


As remaining term of CD gets lower, penalty effectiveness gets higher.

5 Yr CD atremaining term

24 Mo Penalty


Penalty Effectiveness CalculatorOriginal Term (Months) 60Remaining Term (Months) 60Offer Rate 1.50%Penalty Type - (0) Months or (1) % of Principal 1Penalty Amount - % of Principal 5 Annual Penalty In BP 100 Amount of Shock Protection (BP) 100



38


24 Mo Penalty

Penalty specified as a percentage of principal is more effective whenRates are low.

5 Yr CD atremaining term

5% of PrincipalPenalty





39

Protection provided by penalty is independent of rate paid.


CDs - Lessons from This Series• Marginal cost will always be lower if you segment as

opposed to paying up.• That means you need to have decided on your

strategy before rates begin to rise which prepares you for …

• Deploying the segmentation strategy when first drip happens.

• Marginal cost of attracting and retaining rate sensitive CD customers is high. It is even higher for new CDs.

• Paying up for long-term CDs could be ineffective if you lack significant early withdrawal penalties.


Session 2

41

Funding - Developing Funding StrategiesNon-Maturity Deposits


© 2011 Farin & Associates, Inc42

Non-Maturity Deposits• Contractual Behaviors

– Immediately repricable– Immediately withdrawable– Sounds like fed funds

• General Rule– The more features of an account

that are important to a customer other than rate, the less sensitive they will be to rate paid

– NMD Features• Rate• Immediate Access• Transaction Capability

• Actual Behaviors– Rates on some of these accounts

respond moderately and slowly in response to changes in market rates

– Balances are retained for long periods of time in spite of rate behavior

– Acts like: Stable supply, semi-fixed rate, long-term

– Key Inputs to A/L models• How will pricing respond to

changes in rates? (Pricing betas)

• How long will the funds be out there? (Decay rates)

• How much of the balances are non-core? (Surge Balances)


Pricing Betas• Defined - The extent to which a change in market rates is

passed along to a deposit account’s customers.• For example, if market rates increase 200 bp and your

beta for premium MMDAs is 0.6 (60%) then the beta would predict you will raise MMDA rates by 120 bp

200 bp X 0.6 = 120 bp• Betas can be:

• SWAG’d• Derived statistically from historic data (core deposit study)• Examiners prefer the latter

43


Example Core Study Beta Results

44

This is the pricing beta section of an actual core deposit study. If you don’t have your own betas available, you might consider using these for estimating

response to changes in market rates for various kinds of non-maturity deposits.


Non-Maturity Deposit Life• Key Concept

– Non-maturity deposits don’t all ‘mature’ at the same time

– Instead, balances in accounts decay off the books over time

– Decay rates can be statistically measured

– Once measured, decay rates can be used to forecast cash flows coming off pools of non-maturity deposits

• Cash Flow Decay rates affected by:– Life events – death, divorce,

population turnover– Satisfaction with the institution– Movements in market rates and

your pricing strategy.– Economic events – local (plant

closings), and national (911, stock market health, economic outlook, etc.)

– Technology– Interaction between CSRs and

customers– Flight to quality– Relationship between CD and

NMD rates45

For all these reasons, your decay rates could be dramatically different than

national averages.

45


Surge & Decay – From same study as Betas.

46

Decay rates seem low until you consider we are looking at balance decays rather than account number decays.

In a rising rate environment, CD surge balances are likely to return to CDs. As a result, their pricing betas will be close to 1.0.What isn’t surge is core and will have pricing betas more in line with the betas in the core deposit study. In this example, 75.66% of MMDAs are core (100%-24.34%)


Using Results of Core Study• Modeling

– Pricing betas drive cost of funds on non-maturity deposits as rates change in A/L Models. In other words they drive the interest cash flows.

– We also use them in modeling strategies in the marginal cost model.

– Decay rates drive the principal cash flows in A/L models. Crucial to Economic Value of Equity (EVE) calculations.

– Surge balances are a relatively short-term funding source. Beta will be in the range of 1.0 because funds will move back into CDs with a beta of 1.0 or leave for the markets and need to be replaced at market rates

– High beta non-surge (core portion) are a close to variable rate funding source.

– Low beta non-surge (core portion) are a long-term close to fixed-rate funding source.

47


Non-Maturity Deposits• Segmentation Strategies

– Ideally, strategy causes rates to respond very slowly to changes in market rates on non-rate sensitive portion

– Strategy causes rates to respond more quickly to changes in market rates on rate sensitive portion

– Weighted average cost moves relatively slowly in response to changes in market rates

– Lots of barrier to entry options• Product design• Tiers• Transactional• Channel• Geographic

48


Weighted Average Life Argument

49

WALs only look at principal life & drop when rates rise as surges run off. Since WALs fail to consider betas (interest expense cash flows), they aren’t a very good measure of hedging power of NMDs.


Using Duration (Johannes Slide)Chg MV = -D * Chg MR

- .10 = - 5 x .02- .08 = - 8 x .01

Percent Change in Price Duration Change in Interest Rates

$100 $ 90

$10

$90 $81

Example of 1st

case: Rates rise 2% and duration of both assets and liabilities is 5. Both will fall 10% in value


But What If• Change in market rates causes a change in

duration?–Prepayment speeds change on mortgages–Callable bonds get called–Surge balances return to the source

• Solution: Use a simulation model to model changes in cash flows under different rate environments

51


Market Value Sensitivity

52

Today’s market valuesare well below book.

What will happen if rates go up on accounts with high betas?

This is the non-maturity deposit section of an EVE report calculated by a simulation model


Solving the duration equation for Effective Duration

• If: Chg MV = -D * Chg MR• Then: D = -Chg MV / Chg MRThe D in the second formula is the effective duration.

53


Effective Duration - Core

54

Effective Duration looks at how principal and interest cash flows are impacted by changes in rates. It considers decay rates, surge balances, truncation, and pricing betas. These are effective durations of non-surge (core) balances

Eff Dur = - Chg MV / Chg MR



55

30 Yr FRM15 Yr FRMAuto Loans


MMDA Survey Data

56

Pricing strategy is to pay in the bottom third of the market based on survey data.


MMDA – Pay Up

57

Current pricing strategy has maintained savings and money market balances in lastyear so 100% retention is assumed.


MMDA Pay Up

58

Strategy 1 - In 200 bp rising rate environment savings beta used for savings, regular money market beta used for regular MMDAs, Premium MMDA beta used for premiumaccount. Benchmark rate is 2 yr FHLB advance rate plus 125 bp.

FHLB DM

+ 1.25%


MMDA Pay Up

59

Strategy 1 – Based on the historical response to this strategy, retention is assumed to be 100%.


MMDA Pay Up Survey Data

60

Pricing changes deemed necessary for 10% growth. Would take rates at or near the top of the market


MMDA Pay Up

61

Rates are raised on Premium MMDA close to the top of the market. This is a segmentation strategy as I’m only paying up on one of the products in the sector. Other Rates are not changed. Overall sector growth is assumed to be 10%. Marginal cost is 34 bp under the benchmark.


Problem with Premium Accounts• Issue

– Created to attract rate sensitive customers– But over time lobby behavior loads with more and

more non-rate sensitive accounts– We don’t want to pay up for non-rate sensitive funds in

premium service lines• Solution – bottom of rate cycle

– Merge service lines to get everyone back in same pool.– Inexpensive because

• Tiers are compressed• Premium account rates pushed down against regular account rates.

62


Solution – Rising Rates• Introduce new premium product in rising rate

environment.– No balances in premium account when introduced– Rate sensitive funds move to new service lines which is

priced using premium beta from study (+/-)– Merged service line priced using regular account

beta (+/-)

63


New Premium MMDA

64

Old Premium MMDA priced using regular MMDA beta. New Premium MMDA pricednear the top of the market. Similar amount of new money raised at much lowermarginal cost.


Checking Sector• Similar strategies can be used in checking except:

– Checking customers are less rate sensitive thanmoney market customers.

– Some checking products don’t bear interest• Remember the more features of a product that are

important to a customer other than rate, the less sensitive they will be to rate paid.

• Discussion question– What barriers to entry are in a Rewards checking

account?– Is the product really aimed at going after checking

dollars?

65


Questions?

66


Funding- Developing Funding Strategies

Effectively Using Wholesale and Blended Funding

Session 3

Thomas A. FarinChairman of the Board

[email protected]


What is Wholesale Funding• Wholesale Funding – Funding from a source

other than your depositors.• Core Deposits – Regulatory Definition

–Generally exclude wholesale funding–May also exclude funding from customers

considered to be brokered• CDARS• CDs over the FDIC insurance limit

68


Uses of Wholesale Funding1. As a source of liquidity

– In your operating strategy– As part of a contingency funding plan

2. When cost is significantly below the marginal cost of customer deposits

3. As a structured funding source to fund long-term assets

– Balloons– Lock ARMs– Fixed-rate mortgages– Long-term investments

69


Sources of Wholesale Funding• Federal Home Loan Bank• Fed Discount Window• Repurchase Agreements• Fed Funds Purchased• Brokered Deposits• CDARs and similar insured products• Internet CDs (Qwickrate, etc.)

70


Federal Home Loan Bank Advances• Requires collateral• Both term and structured products• Prices at a small spread above the Treasury curve• Uses

– As funding as part of a business plan– As a contingency funding source.– When the marginal cost of retail funding is above

advance rates– As a structured product to fund different classes of assets

71


Fed Discount Window• Requires collateral• Short-Term Funding Sources• Prices close to the Fed Funds Rate• Uses

–As funding as part of a business plan–As a contingency funding source–When the marginal cost of short-term retail

funding is above the discount rate

72


Repurchase Agreements• Requires collateral• Short-Term Funding• Prices at a small spread above or below the

Treasury curve• Uses

–As funding as part of a business plan–As a contingency funding source.–When the marginal cost of retail funding is above

the Repo rate

73


Fed Funds• No collateral required• Overnight funding• Prices above or below the Fed Funds target

rate• Uses

–As funding as part of a business plan–As a contingency funding source.–When the marginal cost of retail funding is above

the Fed Funds rate

74


Brokered CDs• No collateral required• Term products• Prices at a small spread above or below the

Treasury curve. May be cheaper than advances in a rising rate environment.

• Uses– As funding as part of a business plan– As a contingency funding source.– When the marginal cost of retail funding is above

Brokered CD rates– As a structured product to fund different classes of assets

but limited to term bullet funding.75


CDARs and Similar Products• No collateral required• Money Market and Term products• Funds from your customers – deposit insurance extended

beyond $250,000• Prices at a small spread above or below the Treasury

curve. May be cheaper than advances in a rising rate environment.

• Uses– As funding as part of a business plan– As a contingency funding source.– When the marginal cost of retail funding is above CDARs rates– As a structured product to fund different classes of assets but limited

to term bullet funding.

76


Optimal Earning Asset Matrix• Every balance

sheet mix carries maximum return\volatility combinations

• Finding your optimal earnings frontier is key to strategic\capital plan– What strategy has

higher earnings potential and less “risk”

77

What are the most common reasons why you might be performing at the portfolio B level when you could be performing at the A level.

Volatility of earnings

RO

E


Case Institution• $1.5 Billion Deposits – Had been shrinking• Capital Plan allows $30-50 million asset growth next year• Loan/Asset Ratio is low – Loans can grow more than

deposits• Needs to grow to drive down

– Non-earning assets/assets– Operating expenses/assets

• Growth for now goes into investments at relatively low yield• Pressure is for growth to be at low marginal cost• Where should he grow funding

– Wholesale funding– Retail funding

78


Identify Loan Growth Opportunities• Case Institution

– 15 and 30 Year FRMS• Conforming• Non-Conforming

– Fully Amortizing Commercial R/E Loans• 15 Year FRM• 20 Year FRM

• “But, Farin, there is too much interest rate risk in these products!” After all, isn’t that what caused thrifts to fail?

• So we take interest rate risk we could manage and pass it to the customer who can’t manage IRR. What do we get back?

• Why can’t we figure this out?

79


Funding Longer Duration Loans• Options

– Deposits• Long-Term CDs

– Recently Expensive– Will lag the market in

rising rate environments– Uncovered Options

• Non-Maturity Deposits– Cheap source of long-

term funding especially when rates are up.

– But do you bet the whole shop on the results of a core study?

– FHLB Advances• Relatively cheap now• Will lead deposit rates in rising

rate environment• Can be purchased

– With no imbedded options

– With options granted to the FHLB (cheaper)

– With imbedded options granted to the member (more expensive)

• Can raise exactly what you need, at a known rate, when you need it

• Requires collateral– SWAPs, CAPs and other off

balance-sheet instruments 80


Questions• Is management willing to “Bet the Bank” on a Core Deposit

Study? Your career could be at stake.• How will your regulator react to funding long-term fixed-rate

loans entirely with non-maturity deposits? Your CAMEL(S) rating could be at stake.

• Can you convince your Board of Directors that this strategy makes sense? Especially if you’ve told them that portfolioing fixed-rate loans is stupid, especially at the bottom of the rate cycle.

• Is there a better approach?

81


Blended Funding Making LT Assets Using FHLB Advances

• Concept– Use FHLB Advances to provide

structural support under fixed-rate loans

• Partially match the cash flows with totally predictable funding behavior

• Potentially pay a bit more for prepayment protection

• Tradeoffs– Higher cost– You may not need the

funding– But what are you earning on

your investment portfolio now?

– Supplement FHLB Advances with non-maturity deposits to plug funding gap taking advantage of:

• Low cost of NMDs• Lower pricing betas through

segmentation• Decay rates• Inherent extension risk hedge

– Results in:• A close to fully hedged position• Less reliance on the accuracy of

the core study

82



83

30 Yr FRM15 Yr FRMAuto Loans


Remaining Principal Loan/Advance

84

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Outstanding Principal

Loan Rem Prin Adv Rem Prin

Comparing cash flows of a 100% match funded scenario for• 15 Yr Fully Amortizing Commercial Real Estate Loan at 4.5%• Funded with 15 Year Amortizing Advance at 2.68%.

Note that amortizing advance cash flows are right on top of the loan so they are “hidden” in the

graph


Yield/Adv Cost/Blended Cost

85

• Gross Spread – 182 bp • (142 bp w\ prepayment option on adv.)

• Risk/Cost (option& credit) Adjusted Spread – 102 bp• Capital Requirement – 10%• ROE (RAROC) – 10.2% vs 15% Goal


Yield/MMDA Cost/Spread

86

• Gross Spread – 420 bp• Risk/Cost Adjusted Spread – 340 bp• Capital Requirement – 10%• ROE (RAROC) – 34% vs 15% Goal

0.30%

Funding Mix:• 100% MMDA funding

• Assumed beta 30%• Offer rate today

0.30%


Yield/MMDA Cost/SpreadRates Up 500 bp

87

• MMDA Cost – 180 bp (Beta 0.3 * 5% increase in rates plus 0.30% start rate)

• Gross Spread – 270 bp• Risk/Cost Adjusted Spread – 190 bp• ROE (RAROC) – 19% vs 15% Goal

+5% shock


• Assumed beta 30%• Offer rate today

0.30%• Showing cost of MMDA in

+5% shock


Yield/MMDA Cost/SpreadRates Up 500 bp, Beta to 0.6

88

• MMDA Cost – 330 bp(Beta 0.6 * 5% increase in rates plus 0.30% start rate)

• Gross Spread – 120 bp• Risk/Cost Adjusted Spread – 40 bp• ROE (RAROC) – 4% vs 15% Goal

This is a “sensitivity test”!

• Showing cost of MMDA in +5% shock


• Increased beta to 60%

• Offer rate today 0.30%

• Showing cost of MMDA in +5% shock


Comparative ROE’s• Using scenario

testing, find the boundary of acceptable returns and funding mix.

• Review your comfort level regarding non-maturity behaviors

• Don’t bet the institution on the core results

• But, don’t underperform or over pay for risk protection you don’t need!

89


Defining Your Funding Strategy• Concept: Based on core study information, allocation the sources

based on “duration” of cash flows, like you would an investment “ladder”.

• Distribute sources by targeted “amount” and based on “duration”

90

Funding Sources% of Ttl Assets 0-1 Yr 1-3 Yr 3-5 Yr 5-7 Yr 7-10 Yr 10-15 Yr 15-20 Yr > 20 Yr

DDA 10% 5% 25% 30% 25% 15%NOW 10% 5% 25% 30% 25% 15%

Savings 15% 5% 15% 35% 20% 15% 10%MMDA 28% 25% 25% 20% 20% 10%

Retail CDs 7% 75% 15% 10%Brokered CDs 3% 75% 15% 10%

Rate Board CDs 2% 90% 10%Total Deposits 75% 24% 21% 24% 18% 11% 2% 0% 0%

Borrowings 10% 5% 15% 25% 25% 15% 15%

Equity 12% 25% 25% 25% 25%Total Funding Sources 97% 19% 18% 24% 20% 13% 6% 0% 0%

uCore study results should build your “funding” distribution map and validate annu

Documents

Lecture Materials FUNDING - Madison · –Cannibalization assumptions –New money assumptions • But our capital plan has us growing deposits. How about some offensive strategies?