ABAToolb x on Liquidity
ABA Members Only
Tool 2:
Developing a Core Funding Strategy
Through an Initial Strategic Review
Dear Reader,
Welcome to Tool 2 of the ABA Liquidity Toolbox. In this Tool, you will be
introduced to a process you can use to develop a plan to grow your institution’s
Core Funding. While the Interagency Guidance on Liquidity and Funds
Management (Guidance) identifies Core Funding as the most important
non-capital source of a financial institution’s funding, the document does not
address the importance of developing a Core Funding strategy. We thought it
was important to address this strategy in Tool 2.
A Core Funding strategy should address the following:
•
Revising and upgrading internal processes
•
Using appropriate analytics as decision making tools
•
Developing of effective segmentation strategies
Tool 2 lays out those three key implementation components, and provides
examples through the XYZ Bank case study.
Many of the figures created for the XYZ Bank case study in Tool 2 are screen
shots from the software component of Farin & Associates iPrice service.
(To learn more, please visit www.farin.com/pricing/.)
Banker Reviewers
Steven W. Corrie
Senior Vice President
Security National Bank
Sioux City, Iowa
Phil Emma
CFO
Merrimack County Savings Bank
Concord, New Hampshire
J. Robert Kelly
Troy K. Lewis, CPA
Vice President
Heritage Bank
St. George, Utah
ABA Staff Contributors
Mary Frances Monroe
Tom Farin, Farin & Associates, Lead Author
Deanne Johnson de Mariño
Mr. Farin is the author of three separate books on financial institution
asset-liability management, as well as a popular asset-liability newsletter.
Farin & Associates is best known for using technology and education to
help community banks develop and implement retail strategies.
Susan Einfalt
Mark Tenhundfeld
James Chessen
Ryan Zagone
Mako Parker
Keith Leggett
Donna Fisher
Ellen Collier
Rachaell Davis
Lisa Gold Scheier
Robin Gordon
About American Bankers Association
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employees. The majority of ABA’s members are banks with less than $165 million in assets. ABA’s extensive resources enhance the success of the nation’s
banks and strengthen America’s economy and communities.
© 2011 American Bankers Association, Washington, D.C.
This publication was paid for in part with the dues of ABA member financial institutions and is intended solely for their use. Please call 1-800-BANKERS
if you have any questions about this resource, ABA membership or would like to copy or license any part of this publication.
This publication is designed to provide accurate information on the subject addressed. It is provided with the understanding that neither the authors, contributors nor the publisher is engaged in rendering legal, accounting, or other expert or professional services. If legal or other expert assistance is required,
the services of a competent professional should be sought. This guide in no way intends or effectuates a restraint of trade or other illegal concerted action.
Developing a Core Funding Strategy
Through an Initial Strategic Review
Core Funding Growth and Retention
1
Initial Strategic Review of Core Funding
3
Step 1: Divide Core Funding into Sectors and Subsectors
6
Step 2: Review Products by Sectors
10
Step 3: Develop Product Plans to Achieve Funding Goals
16
Step 4: Design Products to Implement Product Plans
20
Step 5: Document Strategies
26
Intro
1
2
3
4
5
Introduction to
the ABA Toolbox
on Liquidity
Developing an
Effective Capital/
Liquidity Plan
Developing a Core
Funding Strategy
Through an Initial
Strategic Review
Integrating
Near-Core and
Non-Core Sources
Into Bank Funding
Measuring Asset
Based Liquidity
with the Liquidity
Coverage Ratio
Developing a
Liquidity Plan
2
Glossary
Benchmark rates – The interest rates on alternative funding sources that are used to
determine whether deposits are well or poorly priced; most common benchmark used by
community banks is FHLB Bullet Advance rates
Decay rate – The annual speed at which balances in a specific group of non-maturity
deposits decline over time
Deposit Sector – A group of deposit accounts that are considered to functionally
equivalent by customers
Initial Strategic Review (ISR) – A process in which an institution’s initial core funding
strategy is developed and documented
Inter-Sector Segmentation – A segmentation strategy that divides customers between
different products offered in a deposit sector
Marginal Cost of Funds – The effective cost of new funds raised as part of a pricing
strategy; considers both the cost of new funds acquired and the additional cost of higher
rates paid to existing customers in order to attract new funds
Segmentation technique – A deposit strategy that attempts to categorize customers by
classes, so products can be designed for specific classes; also used to separate ratesensitive from non-rate-sensitive funds, enabling the institution to attract and retain ratesensitive funds without incurring a higher cost for non-rate-sensitive funds
Target audience – A class of customers that have been identified for which a pricing
strategy or product is designed
Core Funding Growth and Retention
Core Funding is the most favored, lowest cost and most stable source of
funding for a financial institution. However, most regulatory guidance
addressing balance sheet management focuses on managing asset-based
liquidity and Near-Core and Non-Core Funding. Consequently, few smallto medium-sized financial institutions have a Core Funding plan. Tool 2 of
this ABA Toolbox on Liquidity will help institutions develop and document
that plan.
For the purposes of this Toolbox on Liquidity, we divided non-capital
funding into three classes: Core, Near-Core, and Non-Core. Although Tools
2 and 3 will discuss these in detail, here is a brief review of the distinction
between these three classes.
• Core Funding Deposit funding considered to be Core by
regulators. Generally this includes all customer deposits
except CDs with balances over $250,000.
• Near-Core Funding Deposit funding from customers not
considered to be Core by regulators. This includes CDs
over $250,000, deposits placed in reciprocal deposit
networks, and other sources of customer deposits that may
not meet regulatory definitions of Core Funding.
• Non-Core Funding Funding from a variety of sources other
than customers including FHLB advances, brokered CDs,
Internet CDs, brokerage firm deposit sweeps, etc.
It is uncommon for
regulators to use the
terms Core, Near-Core
and Non-Core Funding.
Instead, regulators view
sources of funds on a
scale from less risky
(Core) to more risky
(Non-Core).
Actions taken as part of a Core Funding strategy might raise Near-Core
Funding. For example, a strategy aimed at raising CD funding as part of
a Core Funding strategy will probably also attract CD deposits greater
than $250,000.
The Core Funding Plan is an ongoing process with both strategic and tactical
components. This process interlinks with many other processes within an
institution, especially the plans generated by the asset/liability committee
(ALCO), and the most important of these, the capital liquidity plan (CLP).
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 1
In order to go through the thought process required for a Core Funding
Plan, Tool 2 presents a number of tools:
• Conducting deposit audits
• Using benchmark rates
• Making runoff assumptions
• Using marginal cost analysis (MCA)
As you use these tools and techniques, you will realize that there are changes
you want to make in your product offerings. You may wish to design new
products and terminate others. To do this, you will want to use segmentation
techniques, and erect barriers to entry. Tool 2 will discuss how to use these
tools to create plans and achieve goals related to specific constituencies.
Finally, once the products are reorganized to achieve the goals laid out in the
capital/liquidity plan, you can establish pricing rules for the various account
offerings in the sector.
• Savings products and money market accounts
• Short-term CDs
• Long-term CDs
• Checking accounts
Tool 2 covers the Initial Strategic Review in detail, a process that will aid you
in creating a plan to implement strategies designed to reach the financial
goals you developed in Tool 1. We will see these strategies in practice through
our case study institution, XYZ Bank.
2 |
American Bankers Association
Initial Strategic Review
of Core Funding
In an Initial Strategic Review (ISR), senior management develops an
understanding of product pricing, how products impact the institution’s
liquidity risk and interest rate risk, and how changes in products that help
to achieve liquidity goals affect the institution’s customer base. For example,
new products may better meet the needs of particular constituencies that are
not well-served by existing offerings. The ISR is conducted in five steps:
Step 1 Divide core funding into sectors and subsectors
Step 2 Review products by sector
Step 3 Develop product plans to achieve funding goals
Step 4 Design products to implement the product plans
Step 5 Document strategies
STEP 1
Divide Core
Funding
STEP 2
STEP 3
STEP 4
STEP 5
Review
Products
Develop Product
Plans
Design
Products
Document
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 3
About This Case Study
The ISR helps to create the plans that will enable an institution to accomplish
its goals. The following case study reviews XYZ’s goals, which form a base for
the plans it will soon develop to achieve those goals.
XYZ would like to reduce its reliance on Near-Core and Non-Core Funding. Many
institutions would like to grow Core Funding faster than loans. However, in a
healthy economy, industry loans are likely to outgrow Core Funding, as has been
demonstrated in 13 of the last 18 years. The answer to this conundrum will
come from the planning accomplished in the ISR.
XYZ BANK Case Study
Developing Core Funding Objectives
As XYZ prepares to begin its ISR, senior management
looks back to the financial goals it established with the
ALCO. These strategic goals are shown in Figure 2-1.
XYZ set both loan and Core Funding growth rates at an
8% annual rate.
The Core Funding annual growth rate goals step up
gradually over the 5 years of the forecast, reaching the
strategic goal of 8% in the fourth year. In years 1-4 of the
forecast, the Core Funding growth goals exceed the loan
growth goals, converging at 8% in year 5 of the forecast.
This would result in an 8% asset growth rate. However,
Core Funding growth rate goals vary materially from year
to year as XYZ works through its performance problems
and as the balance sheet mix moves in the direction of
the mix specified in the strategic financial goals. Figure
2-2 compares the annual growth rate goals for Core
Funding to the goals for loan growth.
How will XYZ succeed in growing Core Funding faster
than loans? XYZ plans to outgrow its competitors
while effectively managing funding costs by having a
more effective Core Funding strategy in place. Senior
management may also consider limiting its loan growth
and/or selling a portion of its loan production in the
secondary markets.
Figure 2-1 Strategic Financial Goals
Strategic Financial Goals
ROE
Capital/Assets
ROA
Dividends/Income
Organic Capital Growth
Loan Growth Rate
Investments/Assets
Non-Earning Assets/Assets
Regulatory Core Growth
Non-Regulatory Fund/Assets
Other Liab/Assets
4 |
American Bankers Association
Curr/Rct
-10.75%
8.70%
-1.00%
-13.33%
-12.18%
0.00%
6.50%
8.67%
2.00%
35.91%
0.20%
Goal
12.00%
9.00%
1.08%
33.33%
8.00%
12.00%
7.00%
8.00%
20.00%
0.20%
Balanced
1.08%
8.00%
8.00%
8.00%
Figure 2-2 Annual Growth Goals for Core Funding and Loans
10%
8%
6%
4%
2%
0%
2007
2008
2009
2010
2011
2012
2013
2014
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
Year
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Strat Goal
Year
2007
2008
2009
2010
2011
2012
2013
2014
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
SFG
Core Growth
Ending
Core
164,980
168,280
176,694
189,062
204,187
220,522
Loan Growth
Rate
Ending
Loans
Rate
2.00%
2.00%
5.00%
7.00%
8.00%
8.00%
8.00%
0.00%
-12.00%
-4.00%
2.00%
6.00%
8.00%
8.00%
249,218
219,312
210,539
214,750
227,635
245,846
Ending
Assets
300,000
269,094
261,215
267,102
281,031
303,514
Asset
Growth
0.00%
-10.30%
-2.93%
2.25%
5.21%
8.00%
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 5
STEP 1
Divide Core
Funding
STEP 2
STEP 3
STEP 4
STEP 5
Review
Products
Develop Product
Plans
Design
Products
Document
STEP 1 Divide Core Funding
into Sectors and Subsectors
To begin the ISR, institutions should take a good look at the product mix and
breaks it down into sectors and subsectors. Sectors are groupings of accounts
with similar levels of utility to a customer, and subsectors further refine these
offerings. A sample sector/subsector division follows:
Savings Products
• Savings
• Money Markets
Short-term CDs
• 1-4 month CDs
• 5-9 month CDs
• 10-12 month CDs
The regulatory definition
for a long-term CD is
anything with a maturity
longer than 12 months,
which is the breakdown
that should be used for
call report purposes. This
Tool reviews segmentation
strategies, so our
definition of short-term
CD reaches a bit longer
into the maturity range,
because as consumers
perceive a 13-15 month
CD special as being
functionally equivalent to
a 12 month CD.
6 |
Long-term CDs
•
•
•
•
13-29 months
30-40 months
41-53 months
54+ months
Checking
• Business
• Personal
Savings Both savings and money market account types meet the same basic
need – to set aside a portion of a customer’s liquidity, keeping it out of
the velocity of daily transactions moving through the customer’s checking
account. Institutions separate customers into two behavior classes, those that
are relatively rate-insensitive and those that are relatively rate-sensitive.
CDs Institutions use CDs with different rates and terms to compete for rate-
sensitive customers.
Checking The primary customer need met by the account is to conduct daily
transactions. However, within the checking sector, customers have a variety
of needs and priorities. Institutions address the varying needs and priorities
with different consumer and business checking products.
Funding Trend: CDs Decline as Percent of Funding
One long-term trend affecting the industry is the decline of CDs as a percent of
funding. That decline is likely to continue as wealth passes from seniors to Baby
Boomers, Generation Y, and Generation X.
American Bankers Association
There are two primary reasons CDs may be declining as a percent of funding.
First, seniors historically found it more convenient to invest ‘risk free’ money
in FDIC-insured bank CDs than in U.S. Treasuries. This came about because of
the relative inconvenience of Treasury purchases relative to opening a CD with a
local institution. Today, it is much more convenient to move funds over the web
from an equity mutual fund into a short-term Treasury fund. Convenience has
swung away from bank CDs and in the direction of Treasuries.
Second, most younger people have little knowledge of bank CDs. Ask a Gen Y
customer about bank CDs. In response to your question, the customer is most
likely to open the disk drive on a laptop, pull out the gold disk and ask, “Is this
what we are talking about?”
Two ways that banks have tried to manage this trend are to educate customers
as to the advantages offered by CDs, in an attempt to turn the trend around and
focus on growing non-maturity deposits.
XYZ BANK Case Study
Divide Core Funding
into Sectors and Subsectors
Once XYZ has outlined specific Core Funding growth
objectives senior management examines the composition
of its Core Funding. Figure 2-3 breaks the XYZ Core Funding
into sectors and subsectors. XYZ’s Core Funding is displayed
in thousands of dollars as of 12/31/09 and as a percent of
Core Funding. CDs represent 54.6% of Core Funding. The
remaining 45.4% is in non-maturity deposits. This mix is
fairly typical for the industry. Although XYZ’s management
is tempted to keep the mix constant, it recognizes that CDs
are declining as a percent of Core Funding. Therefore, its
plan will have to reflect this trend.
Figure 2-3 Core Funding by Sector and Subsector
Month/Year
Core Funding
Business Ckg
Personal Ckg
Savings
MMDA
0-4 Month CDs
5-9 Month CDs
10-15 Month CDs
16-29 Month CDs
30-40 Month CDs
41-53 Month CDs
54+ Month CDs
Total
Dec-09
Risk Assets
164,980
Balances Risk Wt.
Mix %
6,580
0.0%
4.0%
13,238
0.0%
8.0%
5,819
0.0%
3.5%
49,202
0.0%
29.8%
496
0.0%
0.3%
12,371
0.0%
7.5%
47,103
0.0%
28.6%
20,047
0.0%
12.2%
4,883
0.0%
3.0%
393
0.0%
0.2%
4,848
0.0%
2.9%
164,980
0.0%
100.0%
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 7
About This Case Study
It would be fairly simple to ignore long-term industry trends and plan for more
of the same. But this will not enable XYZ to achieve its goal of increasing Core
Funding. In the following case study, XYZ senior management struggles with the
kinds of changes it can make in its Core Funding Mix in order to increase Core
Funding even faster than its loans.
YZ BANK Case Study
Regulatory Core Mix
XYZ is concerned about its reliance on CDs as a funding
source. In addition, it has a significant portfolio of CDs
over $250,000, which count as Near-Core Funding, and
brokered CDs, which are Non-Core.
Overall, the goal for 2010 is to maintain a Core Funding
growth rate of 2% in 2010 and shift 5.2% of Core Funding
from short-term CDs into MMDAs. Meanwhile, the ALCO
also wishes to reduce XYZ’s cost of funds in the process.
These goals translate into the balance sheet targets for
2010 shown in Figure 2-4.
In setting goals for Core Funding, the ALCO took the
following issues into consideration:
• Concern about interest rate risk in rising rate
environments for the first 200 bp of market
rate movements: XYZ’s variable rate commercial
loans and HELOCs have floors of 5%. Rates
will need to rise 200 basis points before loan
rates exceed the floors. The ALCO feels that
8 |
American Bankers Association
it would be better to fund the variable-rate
loans with MMDAs rather than short-term
CDs, since MMDA rate increases can be more
readily contained in the first part of a rising rate
environment.
• Desire to be less reliant on CDs:
XYZ management would prefer to be less
reliant on CDs and have more funding in
non-maturity deposits.
• Beneficial effects on Near-Core CDs:
Actions taken to reduce reliance on CDs
would also reduce reliance on Near-Core CDs
(those with balances in excess of $250,000).
As XYZ increases the percentage of MMDAs in its
Core Funding portfolio over the next year, XYZ expects
corresponding reductions in 5-9 and 10-15 month CDs
as a percent of funding. Successful execution of this
strategy will bring XYZ to a Core Funding mix of 50/50
between non-maturity deposits and CDs within one year.
Liquidity risk tolerances or limits should be appropriate
for the complexity and liquidity risk profile of the
institution and should employ both quantitative targets
and qualitative guidelines.
FDIC Financial Institution Letter FIL-84-2008:
Liquidity Risk Management
Figure 2-4 2010 Core Funding Balance Sheet Targets
Core Funding Balances
Business Ckg
Personal Ckg
Savings
MMDA
0-4 Month CDs
5-9 Month CDs
10-15 Month CDs
16-29 Month CDs
30-40 Month CDs
41-53 Month CDs
54+ Month CDs
Total
Dec-09
6,580
13,238
5,819
49,202
496
12,371
47,103
20,047
4,883
393
4,848
164,980
Jan-10
6,591
13,260
5,829
49,284
497
12,392
47,182
20,080
4,891
394
4,856
165,255
Feb-10
6,602
13,282
5,838
50,321
498
11,918
46,845
20,114
4,899
394
4,864
165,576
Mar-10
6,613
13,304
5,848
51,234
498
11,606
46,425
20,147
4,907
395
4,872
165,851
Jun-10
6,646
13,370
5,877
54,321
501
11,331
44,157
20,247
4,932
397
4,896
166,676
Sep-10
6,679
13,437
5,906
56,600
503
11,387
42,366
20,348
4,956
399
4,921
167,501
Dec-10
6,712
13,503
5,935
58,898
506
11,443
40,555
20,448
4,981
401
4,945
168,326
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 9
STEP 1
Divide Core
Funding
STEP 2
STEP 3
STEP 4
STEP 5
Review
Products
Develop Product
Plans
Design
Products
Document
STEP 2 Review Products
by Sectors
Once the products have been organized, offerings are reviewed in detail at
the sector and subsector level. This analysis forms the basis for strategy ideas
that become plans in Step 3.
There are many tools that institutions can use to conduct this review. Three
primary tools are covered in detail on the facing page:
• Deposit Audits
• Benchmark Rates
• Runoff Analysis
In practice, these tools interlock. As an institution reviews each sector,
product by product, it begins to imagine strategies that would help achieve
its goals. It chooses a benchmark rate and then compares strategies by
conducting a runoff analysis to see which might be better in a given sector.
The following three case studies put these tools into practice as XYZ Bank
conducts a detailed analysis of its short-term CDs.
10 |
American Bankers Association
Analysis Strategy 1:
Deposit Audits
A deposit audit reviews balances and rates for the sector being analyzed and compares
those rates with market data. Competitive survey data can be obtained in-house or by
contracting with a survey firm to conduct offering rate surveys for the competitors you
wish to use in your comparisons.
As an institution begins to formulate strategies, it should assess its competitive position
carefully. Some institutions compete with regular accounts and others with premium
or promotional accounts like premium MMDAs or off-maturity CD specials. Unless an
institution incorporates data on premium accounts in its analysis it will not effectively
evaluate its true competitive position.
Analysis Strategy 2:
Using Benchmark Rates
In deciding between two alternative strategies, it makes sense to use rates on readily available Non-Core Funding as a benchmark to determine whether Core Funding is
well- or poorly-priced. Under most circumstances, financial institutions have a number
of choices in funding their balance sheet. They can fund with Core Funding or they can
fund with Near-Core and Non-Core Funding. Clearly, regulators would prefer that banks
fund their balance sheets with Core Funding. It is the least rate sensitive and most
stable source of funding available. Yet there are circumstances in which Core Funding
may be far more expensive than Non-Core Funding. For example, in the past two years,
some troubled institutions aggressively priced insured deposits to maintain funding.
This made insured deposits, a Core Funding source, more expensive than other funding
alternatives, such as FHLB advances.
Decisions as to which funding source to use should not be based solely on which funding source is cheaper. Other customer relationships come with changes in Core Funding
strategy. And, of course, an institution needs to manage its overall level of Near-Core
and Non-Core Funding.
Analysis Strategy 3:
Runoff Analysis
To understand which product subsector to target for higher or lower retention, an institution
can use a worksheet that looks at runoff assumptions. For CDs, runoff assumptions are
based on maturity schedules and generally focus on CDs maturing in the next quarter,
as these are the CD balances that will be exposed to whatever CD pricing strategy is
deployed based on the results of the analysis.
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 11
A deposit audit reviews balances and rates for
the sector being analyzed and compares those
rates with market data.
xyz BANK Case Study
Conducting Deposit Audits
Figure 2-5 is a deposit audit for XYZ’s short-term CD sector.
As you can see, XYZ offers standard term CDs at 3, 6, and
12 months. They are also offering an aggressively-priced,
14-month CD Special. Balances shown include Near-Core
CDs of $12.2 million with balances in excess of $250,000.
XYZ’s rates on regular CDs are well above market median
and the special rates approach the top rates paid in
the market.
XYZ’s short-term CD pricing strategy has resulted in
significant growth in short-term CDs. This includes both
the Core portion and the Near-Core (>$250,000) portion of
these balances. XYZ’s desire to raise CDs is understandable.
Institutions feeling regulatory pressure to reduce their heavy
reliance on Non-Core Funding may find it relatively easy to
grow Core Funding by aggressively pricing short-term CDs.
But before doing so, it is important to understand just how
much such a strategy is costing.
Figure 2-5 XYZ Short-term CD Audit
Balances and Rates As Of Nov-12-2009
Values in Thousands
Short Term CD
0-4 Month CD
3 Mo CD - 1K
3 Mo CD - 25K
3 Mo CD - 50K
5-9 Month CD
6 Mo CD - 1K
6 Mo CD - 25K
6 Mo CD - 50K
10-15 Month CD
12 Mo CD - 1K
12 Mo CD - 25K
12 Mo CD - 50K
14 Mo CD Special
14 Mo CD Special
14 Mo CD Special
12 |
American Bankers Association
Market
All
All
All
All
All
All
All
All
All
All
All
All
All
All
All
All
Balance Offer Rate
72170
671
162
0.90
334
0.92
175
0.98
13707
2515
1.11
9856
1.17
1336
1.27
57792
4915
1.23
13565
1.38
4035
1.46
7508
1.60
21115
1.70
6654
1.80
Tier
Term
25,000
100,000
3
3
3
1,000
25,000
100,000
6
6
6
1,000
25,000
100,000
1,000
25,000
100,000
12
12
12
14
14
14
There are circumstances in which Core Funding
may be far more expensive than Non-Core Funding.
XYZ BANK Case Study
Using Benchmark Rates
XYZ must choose a benchmark rate to use as a comparison
for the MCA they will be carrying out as they consider
potential strategies. To qualify, a benchmark needs to
meet the following criteria:
• Can be used as a true alternative source
of funding
In making the decision between the two, management
might consider:
• Whether XYZ is close to its collateralized
borrowing limits on FHLB advances
• Data is readily available when decisions
are made
• Whether concentration of either source of
Non-Core Funding approaches concentration
limits in XYZ’s liquidity policy
• Complete funding curve, since it is used
in pricing a variety of deposit terms
• Which is the cheaper Non-Core Funding
source at the present time
Given that XYZ purchases both brokered CDs and FHLB
advances, either interest rate curve would be appropriate to
use as a benchmark. Some institutions might compromise
by averaging the two as illustrated in figure 2-6.
• Whether the level of advances or
brokered CDs would trigger additional
FDIC premium expense
XYZ has sufficient collateral for additional FHLB
borrowings, and neither brokered CDs nor FHLB advances
are reaching a concentration policy constraint. The FHLB
advance curve is the most commonly used benchmark for
community banks, as it is the most commonly used source
of Non-Core funding by community banks. Therefore, it
makes sense to use FHLB advances as a benchmark.
Figure 2-6 Benchmark Rate Curves
Term (mo) Brokered FHLB
Average
3
0.60
0.25
0.43
6
0.85
0.35
0.60
12
1.40
0.96
1.18
24
2.10
1.94
2.02
36
2.75
2.89
2.82
60
3.50
4.62
4.06
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 13
XYZ BANK Case Study
Review Runoff Assumptions
XYZ’s goal is to shrink short-term CD balances. Senior
management wants to know what pricing strategy to pursue
to accomplish this goal. First, they look at runoff cash flows,
which can be seen in Figure 2-7.
In completing Figure 2-7, XYZ started with the actual deposit
balances for December, 2009, and set a goal to hit forecast
deposit balances for January, 2010 from Figure 2-4.
Then, XYZ senior management added the annualized cash
flow runoff (AnCF) percentage. This is the percentage of
the balances assumed to mature per year. The assumption
used by XYZ for 0-4 month CDs is 400%. That portfolio
is assumed to roll over completely four times in the next
year. The assumption for 5-9 month CDs is 200%. That
portfolio is assumed to roll over completely two times in
the next year. The assumption for 10-15 month CDs is
100%. That portfolio is assumed to roll over completely
one time in the next year. Immediately to the right is the
assumed dollar cash flow (CshFlw$) during the period.
Because this period is one month, assumed cash flow is
1/12 of the annual cash flow. New Orig is the amount of
new balances that must be booked in January to hit XYZs
Balances goals at the end of January 2010.
Figure 2-8 summarizes the results from the runoff analysis
for the next two months in 2010 (February and March). In
Figure 2-9, periods shift to quarters and show the runoff
analysis for the remaining three quarters of 2010.
Finally, XYZ senior management compared maturities
(CshFlw$) to New originations (New Orig) for 2010 (Figures
2-7, 2-8, and 2-9), which led to the conclusion that a
pricing strategy needs to be implemented that will retain
approximately 80-90% of maturing CDs during the quarter
for 5-9 and 10-15 month CDs.
Figure 2-9 Cash Flows in 2010 ($000)
Month/Year
Core Funding
Business Ckg
Personal Ckg
Savings
MMDA
0-4 Month CDs
5-9 Month CDs
10-15 Month CDs
16-29 Month CDs
30-40 Month CDs
41-53 Month CDs
54+ Month CDs
Total
14 |
American Bankers Association
0
Mix%
AnCF%
CshFlw$
4.0%
15%
252
8.0%
15%
506
3.5%
15%
223
35.0%
25%
3,681
0.3%
400%
506
6.8%
200%
5,722
24.1%
100%
10,139
12.2%
50%
2,556
3.0%
30%
374
0.2%
25%
25
2.9%
20%
247
100.0%
61%
25,231
Figure 2-7 December 2009 - January 2010 Runoff Cash Flows ($000)
Month/Year
Core Funding
Business Ckg
Personal Ckg
Savings
MMDA
0-4 Month CDs
5-9 Month CDs
10-15 Month CDs
16-29 Month CDs
30-40 Month CDs
41-53 Month CDs
54+ Month CDs
Total
Dec-09
164,980
Balances
6,580
13,238
5,819
49,202
496
12,371
47,103
20,047
4,883
393
4,848
164,980
0
Mix % Mix%
AnCF%
CshFlw$ New Orig
4.0%
4.0%
15%
82
93
8.0%
8.0%
15%
165
188
3.5%
3.5%
15%
73
82
29.8%
29.8%
25%
1,025
1,107
0.3%
0.3%
400%
165
166
7.5%
7.5%
200%
2,062
2,082
28.6%
28.6%
100%
3,925
4,004
12.2%
12.2%
50%
835
869
3.0%
3.0%
30%
122
130
0.2%
0.2%
25%
8
9
2.9%
2.9%
20%
81
89
100.0%
100.0%
62%
8,544
8,819
Jan-10
165,255
Balances
6,591
13,260
5,829
49,284
497
12,392
47,182
20,080
4,891
394
4,856
165,255
Figure 2-8 Cash Flow/Retention ($000)
Month/Year
Core Funding
Business Ckg
Personal Ckg
Savings
MMDA
0-4 Month CDs
5-9 Month CDs
10-15 Month CDs
16-29 Month CDs
30-40 Month CDs
41-53 Month CDs
54+ Month CDs
Total
New Orig
281
565
248
6,290
501
5,528
9,338
2,619
392
27
268
20,056
0
Mix%
AnCF%
CshFlw$ New Orig
4.0%
15%
82
93
8.0%
15%
166
188
3.5%
15%
73
83
30.4%
25%
1,027
2,064
0.3%
400%
166
166
7.2%
200%
2,065
1,592
28.3%
100%
3,932
3,595
12.2%
50%
837
870
3.0%
30%
122
130
0.2%
25%
8
9
2.9%
20%
81
89
100.0%
62%
8,559
8,879
Feb-10
Mar-10
165,530
0
165,805
Balances Mix%
AnCF%
CshFlw$ New Orig Balances
6,602
4.0%
15%
83
93
6,613
13,282
8.0%
15%
166
188
13,304
5,838
3.5%
15%
73
83
5,848
50,321
30.9%
25%
1,048
1,961
51,234
498
0.3%
400%
166
167
498
11,918
7.0%
200%
1,986
1,675
11,606
46,845
28.0%
100%
3,904
3,484
46,425
20,114
12.2%
50%
838
871
20,147
4,899
3.0%
30%
122
131
4,907
394
0.2%
25%
8
9
395
4,864
2.9%
20%
81
89
4,872
165,576
100.0%
61%
8,476
8,751 165,851
Jun-10
Sep-10
Dec-10
165,530
0
165,805
0
165,805
Balances Mix%
AnCF%
CshFlw$ New Orig Balances Mix%
AnCF%
CshFlw$ New Orig Balances
6,646
4.0%
15%
249
282
6,679
4.0%
15%
250
283
6,712
13,370
8.0%
15%
501
568
13,437
8.0%
15%
504
570
13,503
5,877
3.5%
15%
220
249
5,906
3.5%
15%
221
251
5,935
54,321
33.8%
25%
3,395
5,673
56,600
35.0%
25%
3,537
5,836
58,898
501
0.3%
400%
501
503
503
0.3%
400%
503
506
506
11,331
6.8%
200%
5,665
5,722
11,387
6.8%
200%
5,693
5,750
11,443
44,157
25.3%
100%
11,039
9,248
42,366
24.1%
100%
10,592
8,781
40,555
20,247
12.2%
50%
2,531
2,631
20,348
12.2%
50%
2,543
2,644
20,448
4,932
3.0%
30%
370
394
4,956
3.0%
30%
372
396
4,981
397
0.2%
25%
25
27
399
0.2%
25%
25
27
401
4,896
2.9%
20%
245
269
4,921
2.9%
20%
246
270
4,945
166,676
100.0%
59%
24,742
25,567 167,501
100.0%
58%
24,488
25,313 168,326
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 15
STEP 1
Divide Core
Funding
STEP 2
STEP 3
STEP 4
STEP 5
Review
Products
Develop Product
Plans
Design
Products
Document
STEP 3 Develop Product Plans
to Achieve Funding Goals
After reviewing the sectors and subsectors in detail and beginning to
think through possible strategies, it is time to make a plan. This will entail
choosing between several options. In order to understand the potential
impact of various options, institutions often conduct MCA. This Analysis
Tool is discussed in detail below. In the next case study, XYZ Bank will
consider a strategy to limit growth on some of its CDs.
XYZ BANK Case Study
Approach 1: Discontinuing the Premium Account
XYZ senior management has determined the need to
implement a pricing strategy that will retain 80-90% of
maturing CDs during 2010 for 5-9 and 10-15 month CDs.
A common approach to limiting growth in a sector is to
discontinue premium accounts. To determine whether this
strategy should be employed, institutions should use MCA.
This example looks at implementation of the strategy for
the first quarter of 2010.
It makes good sense in implementing strategies to devise
a strategy, test it for a quarter, evaluate the success of the
strategy and tune the strategy for the next quarter. As a
result, the marginal cost analysis we will be reviewing looks
out one quarter at a time.
The following is a MCA for the 14-month special.
Strategy 1 Continue the existing strategy; continuing
to pay top rates results in a 10% growth (110%
retention of maturing funds).
The lower portion of Figure 2-10 shows total balances
(thousands) maturing in the next quarter for XYZ’s various
tiers for its 6-month, 12-month, and 14-month CD special
in the far left column. The next four columns show projected
results for Strategy 1, a continuation of XYZ’s existing pricing
strategy. The first column lists current offering rates, and the
second assumed retention percentages of renewing funds.
The overall average cost of retained funds is 1.459% and
overall retained balances are 110.2% of maturities or $23.5
million. Those two numbers also appear in the summary
area for Strategy 1 at the top of Figure 2-10.
The four detailed columns that follow are the results for
Strategy 2. In this strategy, the 14 month special is effectively
discontinued by reducing offering rates to the same as
offered on 12 month CDs. At the same time, all rates are
dropped to the median of the market. The pricing changes are
assumed to reduce retention percentages to 90% resulting
in $19.2 million in balances rebooked at a weighted cost
of 0.7%. These weighted costs and balances appear in the
summary area for Strategy 2.
Strategy 2 Discontinue the 14-month special by
setting rates equal to 12-month CD rates. Rates
on all CDs are reduced to the market median or
below. This strategy assumes 10% shrinkage
(90% retention of maturing funds).
16 |
American Bankers Association
In the summary area, retained balances are multiplied by
weighted average costs to calculate the annual interest
expense on the rebooked funds, which is $342,560 under
Strategy 1, while for Strategy 2 is $150,300. The marginal
effect line looks at the difference between the two strategies.
Analysis Strategy 4:
Marginal Cost Analysis
As institutions consider options for achieving goals, it is critical to consider the potential
impact of various options. The tool used to model these options is marginal cost analysis.
MCA compares the cost effectiveness of multiple potential pricing strategies. When an
institution desires to raise new funding, marginal cost considers both the cost increases
to existing balances as well as the cost of new funds raised. When an institution desires
to drive off funds, marginal cost considers the cost reductions on deposits that stay as
well as the savings on the funds that leave.
Under Strategy 2, balances are reduced by $4,308,010
and interest expense by $192,260. Dividing the change in
expense by the change in balances results in a marginal
savings of 4.5% on the funds leaving the institution.
Marginal Savings
$192,260 / $4,308,000 = 4.463%
XYZ saves an average cost of 1.5% on $4.3 million that
leaves under strategy 2. It also saves the reduction in
average cost from 1.4% to 0.7% on the $19.2 million that
stays under the revised pricing. If XYZ needs the funds,
the Investment Retail Benchmark (Rtl Bench) column
indicates the funds could be replaced with comparable
maturity FHLB advances at a cost of 0.6%, saving 4.1%.
XYZ hopes to replace the funding with MMDAs. It will
need to raise the replacement MMDA funding at a
marginal cost of 4.4% or less in order to accomplish the
shift of funds from CDs into MMDAs and reduce its cost
of funds in the process.
Figure 2-10 Discontinue 14 Month Special and Drop Below Median
Marginal Cost Analysis
Strategy Name:
Strat Sumry
Discontinue 14 Mo Special - Drop below median
Balance Wtd Cost Duration
Strategy 1
23,479.36
1.459%
0.92
Strategy 2
19,171.35
0.784%
0.90
Marginal Effect (S2 - (4,308.01)
4.463%
0.99
Deposit Detail
Deposit Type
Summary
Detail
6 Mo CD - 1K
6 Mo CD - 25K
6 Mo CD - 50K
12 Mo CD - 1K
12 Mo CD - 25K
12 Mo CD - 50K
14 Mo CD Special 14 Mo CD Special 14 Mo CD Special -
Date:
11/20/09 0:00
Investment
Maturities
21,301.50
1,257.50
4,928.00
668.00
1,228.75
3,391.25
1,008.75
1,877.00
5,278.75
1,663.50
Strategy 1
Int Expense Rtl Bench
342.56
0.624%
150.30
0.621%
(192.26)
0.795%
Rate
1.459%
Ret %
110.22%
Balance
23,479.36
1.110%
1.170%
1.270%
1.230%
1.380%
1.460%
1.600%
1.700%
1.800%
105.00%
105.00%
105.00%
95.00%
95.00%
95.00%
124.00%
124.00%
124.00%
1,320.38
5,174.40
701.40
1,167.31
3,221.69
958.31
2,327.48
6,545.65
2,062.74
Duration
0.92
0.50
0.50
0.50
0.99
0.99
0.99
1.16
1.16
1.16
FTP
Spread
Income
0.835%
(74.70)
0.153%
(22.59)
3.624%
52.11
Strategy 2
ROE
0.00%
0.00%
0.00%
Rate
0.784%
Ret %
90.00%
Balance
19,171.35
0.500%
0.550%
0.600%
0.800%
0.900%
1.000%
0.800%
0.900%
1.000%
90.00%
90.00%
90.00%
90.00%
90.00%
90.00%
90.00%
90.00%
90.00%
1,131.75
4,435.20
601.20
1,105.88
3,052.13
907.88
1,689.30
4,750.88
1,497.15
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 17
Using Segmentation
Segmentation strategies are used in developing Core Funding strategies in
two different ways:
1. Separate rate sensitive from non-rate sensitive customers so
the institution can afford to compete for rate sensitive funds.
2. Attract a particular customer constituency by delivering a
product aimed at that constituency.
The application of product design aimed at a particular constituency will be
dealt with later in this Tool.
Inter-sector Segmentation
Customers with
higher balances may
move beyond price
considerations if offered
reciprocal deposits,
where accounts over
$250k can still receive
FDIC coverage.
Inter-sector segmentation separates rate sensitive from non-rate sensitive
customers. Financial institutions exploit this difference in rate-sensitivity by
aggressively raising rates on products like CDs in rising rate environments
while moving rates on products like savings accounts only moderately. This
encourages customers to give up some liquidity. There are some limitations.
For example, younger customers don’t understand and use CDs. So if an
institution communicates to younger customers that they should move funds
into a CD, they may search out better rates elsewhere.
Intra-sector Segmentation
An intra-sector segmentation strategy, illustrated in the following case study, is
one that attempts to separate rate-sensitive from non-rate sensitive funds within
a sector. Intra-sector segmentation strategies do not require that customers trade
accounts with one form of liquidity for another.
The limitation of intra-sector segmentation is that there is often very little
differentiation in features between regular and premium products, other than
the interest paid. Therefore, customers can easily take advantage of the
opportunity to gain a better rate.
18 |
American Bankers Association
XYZ BANK Case Study
Approach 2: Segmentation
As an alternative to the strategy of discontinuing premium
accounts, XYZ might consider implementing an intrasector segmentation strategy that separates rate-sensitive
money from non-rate sensitive money.
Strategy 1 Continue the existing strategy, assuming
that continuing to pay the top of rate in the market
results in a 10% growth (110% retention of
maturing funds).
Strategy 2 The offensive CD special in Strategy
1 is converted into a defensive CD special that is
priced near market midpoint. Keeping the special
allows further reductions in rates on regular CDs.
The following chart shows the results of the MCA. Marginal
savings on the deposit outflow is 4.8% rather than the
4.4% savings in the scenario in Figure 2-10 on page 17.
If the segmentation scenario in Figure 2-11 is executed,
XYZ would reduce its funding cost by replacing the
outgoing CDs with FHLB advances at a marginal cost
of less than 4.8%.
It may not seem that retaining the special in Figure 2-14 is
worth the additional effort required. One of the reasons the
differential between the results of the scenarios in Figures
2-9 and 2-10 is small is that the difference between
regular CD and special rates tends to be compressed at
the bottom of the rate cycle. Keep in mind that in an
economic recovery scenario where rates rise, XYZ is likely
to raise its special rates more aggressively than rates on
regular CDs. As a result, XYZ will see an increase in the
differential between a strategy of not employing specials
(Figure 2-9) versus one employing specials (Figure 2-10 ).
With the intense regulatory pressure on reducing reliance
on Near-Core and Non-Core Funding, marginal cost can be
a very effective tool in explaining and supporting decisions
to examiners. To see the value, turn scenario 2-11 around.
What if Strategy 2 represented XYZ’s current pricing
strategy? XYZ needs to grow funding by $4.4 million to
fund existing loan demand. Its two alternatives could be
raising rates on existing CDs or borrowing the funds from
the FHLB. The analysis shows that the increase in funds
of $4.4 million in Strategy 1 would incur a marginal cost
of 4.8%. As an alternative, similar term funding could be
borrowed from the FHLB at 0.6%. An examiner would be
hard-pressed to argue you should have raised the funds in
the retail markets at a marginal cost of 420 basis points
above the Non-Core Funding alternative.
We will revisit this issue in Tool 3, where we will consider
the use of Near-Core and Non-Core Funding.
Figure 2-11 Convert Offensive to Defensive Special and Cut Regular Rates
Marginal Cost Analysis
Strategy Name:
Strat Sumry
Strategy 1
Strategy 2
Marginal Effect (S2 - S1)
Deposit Detail
Deposit Type
Summary
Detail
6 Mo CD - 1K
6 Mo CD - 25K
6 Mo CD - 50K
12 Mo CD - 1K
12 Mo CD - 25K
12 Mo CD - 50K
14 Mo CD Special - 1K
14 Mo CD Special - 25K
14 Mo CD Special - 50K
Offensive to Defensive Special - Cut regular rates
Balance
Wtd Cost
23,479.36
1.459%
19,124.10
0.709%
(4,355.26) 4.754%
Maturities
21,301.50
1,257.50
4,928.00
668.00
1,228.75
3,391.25
1,008.75
1,877.00
5,278.75
1,663.50
Duration
0.92
0.93
0.85
Strategy 1
Date:
Int Expense
342.56
135.50
(207.06)
Investment
Rtl Bench
0.581%
0.590%
0.581%
Duration
0.92
Rate
1.459%
Ret %
110.22%
Balance
23,479.36
1.110%
1.170%
1.270%
1.230%
1.380%
1.460%
1.600%
1.700%
1.800%
105.00%
105.00%
105.00%
95.00%
95.00%
95.00%
124.00%
124.00%
124.00%
1,320.38
5,174.40
701.40
1,167.31
3,221.69
958.31
2,327.48
6,545.65
2,062.74
0.50
0.50
0.50
0.99
0.99
0.99
1.16
1.16
1.16
11/20/09 0:00
Spread
0.878%
0.119%
4.173%
Strategy 2
FTP
Income
(74.70)
(15.92)
58.78
ROE
0.00%
0.00%
0.00%
Rate
0.709%
Ret %
89.78%
Balance
19,124.10
0.450%
0.450%
0.500%
0.500%
0.600%
0.700%
0.800%
0.900%
1.000%
80.00%
80.00%
80.00%
70.00%
70.00%
70.00%
110.00%
110.00%
110.00%
1,006.00
3,942.40
534.40
860.13
2,373.88
706.13
2,064.70
5,806.63
1,829.85
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 19
STEP 1
Divide Core
Funding
STEP 2
STEP 3
STEP 4
STEP 5
Review
Products
Develop Product
Plans
Design
Products
Document
Design Products
to Implement Product Plans
STEP 4
Sometimes, small changes in strategy with a particular product are not
enough to accomplish the goal at hand. In these cases, new products may
need to be developed. Effective design of customer deposit products is made
up of three interacting pieces:
Various government
agencies, such as the
U.S. Census Bureau,
are repositories
of demographic
information. For example,
the Federal Reserve’s
Survey of Consumer
Finances is a triennial
survey of the balance
sheet, pension, income,
and other demographic
characteristics of U.S.
families. Additionally,
consulting firms survey
consumers about their
financial habits.
• Identifying the target audience
• Designing the product to admit the target audience
• Setting rates in a way to attract a target audience
Identifying Target Audience
Demographic information for potential target audiences is helpful in
product design, because these statistics provide insight into the differences
in behaviors for the demographic groups. Figure 2-15 identifies six
demographic groups and compares their market composition and customer
composition. This kind of information shows the percentages of customers
using CDs, savings accounts, money market accounts and checking; average
balances by demographic group for the products are also provided; and, for
checking customers, average debit transactions per month, and percentages
using Internet banking and bill pay.
Institutions can use information like this to target products at specific audiences.
Figure 2-12 Sample Demographic Study
Demographic Group
20 |
Market % Inst %
% CDs
Avg CD($) % Sav
Avg Sav($)% MM
Avg MM($) % Ckg
Avg Ckg($)Deb/Mo
% IB
% BP
HS/College
15%
10%
1% $
1.0
30% $
0.5
1% $
0.5
10% $
0.5
25
85%
Paycheck-to-Paycheck
25%
20%
2% $
5.0
15% $
1.0
1% $
0.5
35% $
1.0
8
15%
8%
CG < 30 Years
15%
10%
5% $
5.0
5% $
5.0
10% $
5.0
20% $
8.0
25
75%
65%
CG 30-50 Years
10%
10%
15% $
15.0
10% $
15.0
20% $
10.0
35% $
10.0
15
55%
45%
Affluent 50-65 (Boomers)
15%
20%
40% $
25.0
30% $
25.0
40% $
20.0
45% $
15.0
8
35%
25%
Affluent Seniors
20%
30%
50% $
50.0
50% $
50.0
15% $
65.0
55% $
20.0
2
10%
6%
American Bankers Association
15%
Using Rates to Attract Target Audiences
Often, premium or promotional products are designed to attract audiences
from particular sources. Examples include the following:
• Minimum balance requirements or tiered pricing blocks entry from
customers in certain balance ranges while admitting customers in
other balance ranges.
• Geographic segmentation strategies offer more aggressive pricing in
one market or channel than in others. A grand opening special is a
common example of a geographic segmentation strategy.
• New money requirements reward existing or new customers bringing
in new balances with a more aggressive rate. A rate 25 basis points
higher to a renewing or new CD customer bringing $25,000 in new
balances is an example of a new money barrier to entry.
• Relationship incentives pay higher rates to customers who meet
individual, household, or business relationship criteria. Paying a rate
35 basis points higher to retain a renewing CD customer who has
a $5,000 average collected balance in checking is an example of a
relationship barrier to entry.
• Channel barriers to entry admit customers using one transaction or
delivery channel while blocking those not using that transaction
or delivery channel. An internet-only savings account that offers a
materially higher rate than paid on regular savings, but prohibits the
customer from conducting transactions in a branch is an example of
a channel barrier to entry.
• Transaction barriers offer aggressive rates to customers meeting
certain transaction criteria while paying lower rates to customers not
meeting the transaction criteria. A reward checking account that
pays a 3 percent rate in any month in which a customer conducts at
least 15 debit card transactions is an example of a transaction barrier
to entry.
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 21
Using Inter-sector Segmentation
These strategies
raise new funds from
customers targeted
by the product while
reducing cannibalization
from customers who are
blocked by the barrier.
Strategies used to attract a target audience can be a very effective
segmentation tool. These strategies raise new funds from customers
willing to meet the product requirements by the product while reducing
cannibalization from customers who do not.
For example, if you wanted to design a product aimed at Generation Y
that didn’t attract affluent seniors, you might focus on debit card, Internet
banking, and bill payment usage requirements. All three are much higher
for Generation Y than for affluent seniors. (See Figure 2-12 on page 20.)
Checking accounts that pay a high rate might be appealing to Generation Y
customers who may not carry high balances in savings products. In order to
attract Generation Y and not older more affluent high balance customers,
you may create a checking product that requires monthly Internet banking
log-ons and has a minimum debit card transaction cut-off.
XYZ BANK Case Study
Approach 3: Tiered Barrier to Entry with Segmentation
One of the objectives of the ALCO was to grow money
market accounts. The balances are concentrated in
the Generation X, Boomer and Senior populations. XYZ
senior management wants to admit those customers
while blocking cannibalization from other customers.
They decided to try a tiered barrier to entry.
balance growth based on this pricing. But the plan calls
for significant money market growth over the next quarter.
In fact, management has determined that it will need
to add $1.9 million in newly opened MMDA balances in
March in order to hit its target of $51.2 million by the
end of March.
See Figure 2-13, the deposit audit for the XYZ Money
Market sector. XYZ offers both a regular and a premium
money market. It introduced the premium money
market account 3 years ago, and priced it slightly more
aggressively than the regular account. Of the $49.2
million in money markets, just over 50%, $25.8 million,
is in the premium account.
The annual decay rate for MMDAs is assumed to be 25%.
In March, on a beginning balance of $50.3 million, a
25% decay rate translates into $12.6 million per year or
$1.0 million a month. This means that if XYZ is going to
meet its goal of raising $1.9 million in new MMDAs, then
for each dollar of MMDAs XYZ loses, it will need about
two dollars of new money. Senior management is tasked
with finding a way to accomplish this at a reasonable
marginal cost.
XYZ premium money market rates are in the top 1/3
of the market, but well below the top rates paid in the
market. The regular account rates are in the bottom 1/3
of the market. XYZ is currently seeing no money market
22 |
American Bankers Association
$1 million growth in a month on a $50 million base is
about 2% a month or about 6% a quarter, XYZ’s goal for
Analysis Strategy 5:
Decay Rates
The decay rate can be calculated by noting all of the non-maturity deposits at a point
in time, say December 31, 2007. Then watch what happens to the balances in that set
of accounts over a period of time, until December 31, 2009. Some accounts will close in
that two-year period and balances in others will change. Overall, the balances are likely
to be lower. Convert the balance change as a percent of the beginning balance into an
annual decay rate.
Once a decay rate for a deposit account has been established it can be used in projecting
future cash flows from the same account or a similar account. Decay rates are commonly
used in projecting cash flows for market value calculations, such as economic value of
equity or net present value. They are also useful in liquidity analysis. And in the XYZ
case studies, they will help us project how much cash flow from non-maturity deposits
we need to replace to maintain constant balances.
MMDA growth. This translates into 24% MMDA growth
a year. It will take aggressive pricing to reach that goal.
be to look to the premium MMDA and raise rates there.
Figure 2-14 shows how this plays out in the MCA.
The natural tendency by most pricing committees will
Figure 2-13 XYZ Money Market Audit
XYZ Money Market Audit
Balances and Rates As Of Nov-12-2009
Values in Thousands
MMDA
MM - 2.5K
MM - 25K
MM - 50K
MM - 100K
MM - 250K
MM - 500K
Premium MM - 50K
Premium MM - 100K
Premium MM - 250K
Premium MM
All
All
All
All
All
All
All
All
All
All
All
Market
Balance
Offer Rate
49,202
793
0.34
2,773
0.51
3,591
0.66
8,956
0.75
4,925
0.86
2,325
1.05
6,872
0.80
5,456
0.90
7,575
1.00
5,936
1.25
Tier
2,500
25,000
50,000
100,000
250,000
500,000
50,000
100,000
250,000
500,000
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 23
XYZ BANK Case Study
Approach 3, Continued
Strategy 1 With a continuation of existing MMDA
pricing, MMDA growth stalls at its current level.
No additional cannibalization from regular MMDA
accounts into premium accounts is assumed. The
premium account has been on the books for 3
years. If customers were going to move for a slightly
higher rate they would have moved by now.
Upon seeing this analysis, senior management thinks that
XYZ can do better. They decide to try another approach,
shown in Figure 2-15. They create a new premium money
market with barriers that would limit cannibalization from
the current premium money market.
Strategy 1 As before, with a continuation of
existing MMDA pricing, MMDA growth stalls at its
current level. No additional cannibalization from
regular MMDA accounts into premium accounts is
assumed. The premium account has been on the
books for 3 years. If customers were going to
move for a slightly higher rate they would have
moved by now.
Strategy 2 Rates on Premium MMDA accounts are
raised by 30 bp. Resulting rates are near the top
of the market. Note that this account has a barrier
to entry at $50,000. Additional cannibalization of
5% is assumed from the regular MMDA customers
eligible for the premium account because of the
additional rate differential.
Under Strategy 2, balances grow by just under 6%, so
raising the rates on the premium money market achieves
balance goals. However, the marginal cost of the new
$2.9 million in new money is 4.1%, 0.5% above the
FHLB benchmark. The marginal cost is also just under
the marginal savings from the CD strategy which was
either 4.4% (Figure 2-10, page 17) or 4.8% (Figure 2-11,
page 19) depending on which of the two CD strategies
was deployed.
Strategy 3 Rates on the existing premium money
market are reduced to rate paid on the existing
money market account. The new premium money
market is priced identical to rates paid on the
existing account in Strategy 2 in Figure 2-14.
Figure 2-15 shows the effect of introducing a new
premium money market as opposed to raising rates on the
existing account.
Figure 2-14 Pay Up on Existing Premium MMDA
Strategy Name:
Strat Sumry
Pay up on Premium MM
Date:
Balance Wtd Cost Duration Int Expense Rtl Bench
Strategy 1
49,202.00
0.871%
4.14
428.51
3.672%
Strategy 2
52,088.00
1.052%
6.22
547.87
3.696%
Marginal Effect (S2 - S 2,886.00
4.136% 41.68
119.37
3.672%
Deposit Detail
Deposit Type
Summary
Detail
MM - 2.5K
MM - 25K
MM - 50K
MM - 100K
MM - 250K
MM - 500K
Premium MM - 50K
Premium MM - 100K
Premium MM - 250K
Premium MM
24 |
11/17/09
Investment
Maturities
49,202.00
793.00
2,773.00
3,591.00
8,956.00
4,925.00
2,325.00
6,872.00
5,456.00
7,575.00
5,936.00
Strategy 1
Rate
0.871%
Ret %
Balance
100.00% 49,202.00
0.340%
0.510%
0.660%
0.750%
0.860%
1.050%
0.800%
0.900%
1.000%
1.250%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
American Bankers Association
793.00
2,773.00
3,591.00
8,956.00
4,925.00
2,325.00
6,872.00
5,456.00
7,575.00
5,936.00
Duration
4.14
4.12
4.17
4.16
4.16
4.16
4.16
4.12
4.12
4.11
4.11
FTP
Spread
-2.801%
-2.644%
0.464%
Strategy 2
Rate
1.052%
0.340%
0.510%
0.660%
0.750%
0.860%
1.050%
1.100%
1.200%
1.300%
1.550%
Income
7,505.95
7,673.49
167.54
ROE
0.00%
0.00%
0.00%
Ret %
Balance
105.87% 52,088.00
100.00%
100.00%
95.00%
95.00%
95.00%
95.00%
115.00%
115.00%
115.00%
115.00%
793.00
2,773.00
3,411.45
8,508.20
4,678.75
2,208.75
7,902.80
6,274.40
8,711.25
6,826.40
As expected, balances grow by just under 6%, so raising
the rates on the premium MMDA achieves balance goals.
However, the marginal cost of the new money comes
in at 1.3% (Marginal Effect, Figure 2-15) rather than
4.1% (Marginal Effect, Figure 2-14), an interest expense
savings of $82,000 per year resulting from raising $2.88
million of new funds at a 285 bp lower marginal cost.
Even better, $7.5 million of CDs run off at a savings of
at least 4.5%. (See Figure 2-10, page 17). These will
be replaced with MMDAs at a marginal cost of 1.3%.
That translates into a marginal savings of at least 3.2%
on all balances shifted. Senior management expects the
pricing committee to ask a question: Why would 70%
of premium money market customers stick with the old
account rather than moving to the new account?
Management is prepared with answers:
• The existing premium money market account is
three years old.
• Front line people put all the qualifying accounts
opened in the last three years in the premium
service line whether they were rate sensitive
or not.
• If the customers were very rate sensitive, they
would be at another institution by now, since
we currently pay rates well below the top of
the market.
Figure 2-15 New Premium MMDA
Strategy Name:
Strat Sumry
New Premium MMDA
Date:
Balance Wtd Cost Duration Int Expense Rtl Bench
Strategy 1
49,202.00
0.871%
4.14
428.51
3.672%
Strategy 2
52,085.45
0.894%
4.13
465.58
4.002%
Marginal Effect (S2 - S 2,883.45
1.286%
4.08
37.07
3.672%
Deposit Detail
Deposit Type
Maturities
Summary
49,202.00
Detail
MM - 2.5K
793.00
MM - 25K
2,773.00
MM - 50K
3,591.00
MM - 100K
8,956.00
MM - 250K
4,925.00
MM - 500K
2,325.00
Premium MM - 50K
6,872.00
Premium MM - 100K
5,456.00
Premium MM - 250K
7,575.00
Premium MM
5,936.00
New Prem MM - 50K
0.00
New Prem MM - 100K
0.00
New Prem MM - 250K
0.00
New Prem MM - 500K
0.00
11/17/09
Investment
Strategy 1
Rate
0.871%
Ret %
Balance
100.00% 49,202.00
0.340%
0.510%
0.660%
0.750%
0.860%
1.050%
0.800%
0.900%
1.000%
1.250%
0.000%
0.000%
0.000%
0.000%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
0.00%
0.00%
0.00%
0.00%
793.00
2,773.00
3,591.00
8,956.00
4,925.00
2,325.00
6,872.00
5,456.00
7,575.00
5,936.00
-
Duration
4.14
4.12
4.17
4.16
4.16
4.16
4.16
4.12
4.12
4.11
4.11
4.11
4.11
4.11
4.11
FTP
Spread
-2.801%
-3.108%
-2.387%
Strategy 3
Income
7,508.91
12,541.11
5,032.20
ROE
0.00%
0.00%
0.00%
Rate
0.894%
Ret %
105.86%
Balance
52,085.45
0.340%
0.510%
0.660%
0.750%
0.860%
1.050%
0.660%
0.750%
0.860%
1.050%
1.100%
1.200%
1.300%
1.550%
100.00%
100.00%
95.00%
95.00%
95.00%
95.00%
70.00%
70.00%
70.00%
70.00%
0.00%
0.00%
0.00%
0.00%
793.00
2,773.00
3,411.45
8,508.20
4,678.75
2,208.75
4,810.40
3,819.20
5,302.50
4,155.20
2,850.00
2,750.00
3,350.00
2,675.00
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 25
STEP 1
Divide Core
Funding
STEP 2
STEP 3
STEP 4
STEP 5
Review
Products
Develop Product
Plans
Design
Products
Document
STEP 5 Document Strategies
Once core funding strategies have been developed and modeled, the
documentation of strategies and conclusions should be included in your
institution’s overall liquidity plan. A blank Core Strategy Worksheet is
provided at the end of this section and is also available at www.aba.com/
LiquidityToolbox.
Overall Strategic Goals
The long-term strategic goal worksheet in the capital planning model can be
included with documentation for this section.
XYZ’s strategic goal is to grow capital through retained earnings, loans, and core funding at the
annual rate of 8% per year. These goals should synchronize asset growth, capital growth, loan/
investment mix, and Core to Near-Core and Non-Core Funding mix over the long haul.
XYZ
Strategic Financial Goals
26 |
Strategic Financial Goals
ROE
Capital/Assets
ROA
Dividends/Income
Organic Capital Growth
Loan Growth Rate
Investments/Assets
Non-Earning Assets/Assets
Regulatory Core Growth
Non-Regulatory Fund/Assets
Other Liab/Assets
American Bankers Association
Curr/Rct
-10.75%
8.70%
-1.00%
-13.33%
-12.18%
0.00%
6.50%
8.67%
2.00%
35.91%
0.20%
Goal
12.00%
9.00%
1.08%
33.33%
8.00%
12.00%
7.00%
8.00%
20.00%
0.20%
Balanced
1.08%
8.00%
8.00%
8.00%
Goals for Core Funding Growth
The Annual Growth Goals for Core Funding from the capital planning
model can provide the documentation for this section.
XYZ plans to grow Core Funding faster than loans in the 2010-2012 years in order to:
1. Increase the level of highly liquid unencumbered marketable securities in order to better serve
potential liquidity needs; and
XYZ
2. Reduce the reliance on Near-Core and Non-Core funding to a level more in line with its longterm goals.
In 2013 and 2014, growth rates for both Core Funding and loans will be brought into line with the
speed of capital accumulation through retained earnings as XYZ’s earnings are brought toward their
long-range goals.
Annual Growth Goals for Core Funding and Loans
10%
8%
6%
4%
2%
0%
2007
2008
2009
2010
2011
2012
2013
2014
Year
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Strat Goal
Core Growth
Rate
2.00%
2.00%
5.00%
7.00%
8.00%
8.00%
8.00%
Ending
Core
164,980
168,280
176,694
189,062
204,187
220,522
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 27
Goals for Core Funding Mix
As part of its overall core funding strategy, XYZ plans to reduce its reliance on short-term CDs and
increase its level of money market accounts so that by the end of 2010, non-maturity deposits will
be at a 50%-50% balance with CDs.
XYZ
Core Funding Mix
Non-Maturity Dep
Business Ckg
Personal Ckg
Savings
MMDA
0-4 Month CDs
5-9 Month CDs
10-15 Month CDs
16-29 Month CDs
30-40 Month CDs
41-53 Month CDs
54+ Month CDs
…
…
Total
Dec-09
4.0%
8.0%
3.5%
29.8%
0.3%
7.5%
28.6%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Jan-10
4.0%
8.0%
3.5%
29.8%
0.3%
7.5%
28.6%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Feb-10
4.0%
8.0%
3.5%
30.4%
0.3%
7.2%
28.3%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Mar-10
4.0%
8.0%
3.5%
30.9%
0.3%
7.0%
28.0%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Jun-10
4.0%
8.0%
3.5%
32.6%
0.3%
6.8%
26.5%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Sep-10
4.0%
8.0%
3.5%
33.8%
0.3%
6.8%
25.3%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Sep-10
4.0%
8.0%
3.5%
35.0%
0.3%
6.8%
24.1%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
Dec-10
4.0%
8.0%
3.5%
35.0%
0.3%
6.8%
24.1%
12.2%
3.0%
0.2%
2.9%
0.0%
0.0%
100.0%
XYZ
Core Funding Strategy – Short-Term CDs
28 |
Products: XYZ offers 3, 6, and 12 month tiered regular CDs. We also offer a 14 month tiered CD
special. XYZ contemplates no changes in these product offerings over the next 12 months other
than a possible term change for the specials.
Pricing Rules: Pricing strategies will make use of defensively priced CD specials. The general
strategy will be to price regular CDs at or below the 50th percentile based on survey data. CD
specials will be priced at the 60th to 70th percentile based on survey data.
American Bankers Association
XYZ
Core Funding Strategy – Long-Term CDs
Products: XYZ offers 24, 36, and 48 and 60 month tiered regular CDs. At this point no changes are
contemplated in these product offerings.
Pricing Rules: XYZ has priced long-term CDs generally in the 75th percentile based on survey data.
No change is currently contemplated for this pricing strategy.
Core Funding Strategy – Savings/Money Market
XYZ
Products: XYZ offers a tiered regular money market and a tiered premium money market.
Approximately 65% of balances are in the premium service line. XYZ contemplates introduction of a
new premium money market account with a $50,000 barrier to entry.
Pricing Rules: Once the new premium money market is introduced, it will be priced at the 75th to
85th percentile based on survey data. Rates on the existing premium money market account will be
reduced to the 50th percentile of the market depending on tier. The current regular money market
will be priced in the 33rd percentile of the market depending on tier.
XYZ
Core Funding Strategy – Checking
Products: XYZ offers a free checking account and a tiered NOW account to consumers. XYZ feels a
rewards-style checking account might be used in the future to go after Gen Y customers. However,
with limited needs for core funding growth it makes sense for XYZ to hold off on introducing such a
product until needs for core funding growth develop.
Pricing Rules: The current pricing rule is to price the NOW account in the bottom 1/3 of the market
based on survey data. At this point XYZ contemplates no change in this strategy.
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 29
The following page contains a blank worksheet for you to use in documenting
your Core Funding strategy. The blank worksheet is also available at www.aba.
com/LiquidityToolbox.
As we move forward, Tool 3 will address the use of Near-Core and Non-Core
Funding as part of your liquidity plan. We will also discuss changes in the
Core Funding strategy that might be made to deal with liquidity stress events.
30 |
American Bankers Association
ABA Toolbox on Liquidity
Core Funding Strategy Worksheet
Institution:
Date Completed:
Completed By:
Overall Strategic Goals
Goals for Core Funding Growth
Goals for Core Funding Mix
Core Funding Strategy
Short-Term CD Sector
Products:
Pricing Rules:
Long-Term CD Sector
Products:
Pricing Rules:
Savings/Money Market Sector
Products:
Pricing Rules:
Checking Sector
Products:
Pricing Rules:
Core Funding Strategy Worksheet is available for download at www.aba.com/LiquidityToolbox
ABA Toolbox on Liquidity — Tool 2: Developing a Core Funding Strategy
| 31
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