Maximizing Deposit Margin and Growth In Low RateEnvironment

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Copyright © 2020 BB Analytics

Maximizing Deposit Margin and Growth In Low Rate EnvironmentNov. 18 , 5 pm EST

BankingBook Analytics | Webinars Series 2 | Episode 2

Moderator

Andrew (Andy) PoprawaSenior [email protected]

Sohail FarooqChief Executive Officer [email protected]

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Paola SaadChief Commercial Officer [email protected]

Expert Panel

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Content

House-keeping & Introduction1

2 Current State Analysis

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Deposit Analytics to Consider3

Deposit Retention Strategies4

Key Benefits

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Content



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Analytics to Consider3


Key Benefits

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House-keeping Announcements

• Disclaimero The information, data and approaches provided herein are an outcome of our

research and content expertise. Although we may refer to third party materials and/or analyze their impact, the content is the outcome of BankingBook Analytics’ (BBA) proprietary knowledge and is rightfully owned by us. This work is copyright protected and legally privileged

o BBA has made the best efforts to ensure that this material is complete in its entirety. However, we do not warrant its completeness, accuracy, usefulness or satisfaction with all requirements

• Questionso Questions can be submitted throughout the presentation

§ Via chat to the entire audience§ Via email ([email protected]) without attribution to the audience

• Recordingo This webinar is being recorded and the recording would be made available at

BankingBook Analytics’ YouTube channel at the following link: https://www.youtube.com/channel/UCUPlBMdE7ILLefL2ICW38Kw/

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https://www.youtube.com/channel/UCUPlBMdE7ILLefL2ICW38Kw/

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BankingBook Analytics develops decision support systems for financial services organizations using precision analytics

Advisory

• We create superior value for retail, commercial banks and credit unions by delivering information, analyses, and automated solutions to improve revenue generation across pricing, product development, treasury and risk management, distribution, marketing, and sales management

SaaS Solutions

• Our pre-built data-driven technology solutions are offered as SaaS providing coverage in the following domains:

o Finance: Planning and forecasting applications

o Operations and Treasury: Behavior and profitability applications

o Risk: Risk modelling & quantification applications

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Our solutions focus on key domains, such as, Finance & Treasury, Operations, and Risk

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Planning and Forecasting Behavior and Profitability Risk Quantification & Compliance

• A powerful tool for day-to-day strategic planning and capital management

• A mortgage renewal platform

• Industry leading platform designed to industrialize model risk management

• Integrates security management systems with enterprise-wide risk management framework and helps develop plans to tackle cyber threats

• Provides granular loan pricing analytics

• Provides integrated view of capital for material risks, using a modelling engine attuned to the credit cycle

• Offers price optimization in retail consumer lending

• Assesses market opportunity and recommends strategies to rationalize branch networks’ operations

ScenarioFrontierTM

ECAPLeaderTM

MortgageRetainerTM

CreditStreamTM

RetailEdgeTM

ModelTekTM

BranchScapeTM

Cyber360TM

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Our services push the cutting edge of advanced analytics to guide transformation and boost effectiveness of strategic decision making

o Basel Complianceo Implementation of Federal Reserve’s Requirementso Implementation of IFRS 9 and CECL Requirementso Independent Models Validation

o Asset/Liability Management (ALM)o Credit Scoring and Portfolio Managemento Liquidity Managemento Responding to Rate Changeo Revenue and PPNR Modellingo Comprehensive Capital Management

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Finance, Treasury & Risk Services

Non-financial Risk Regulatory Compliance

Pricing & Profitability

Services

o Middle-Market Banking Optimization

o Corporate and Retail Loan Pricing

o NFR Strategy and Functional Designo Integrated Risk Taxonomyo Control Frameworko Integrated & Forward-Looking Risk and Control Assessmento Cyber Risk Assessment

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We bring a broad set of tools, frameworks, and methodologies to facilitate efficiency improvement initiatives

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Description Examples

Benchmarks and Best Practices

• Fact base developed through extensive experience or research

• Functional Best Practices and Performance Benchmarks (Processes, Systems, Skills, Organization) in Product Development, Customer Service, Marketing, Sales, IT, & Support Functions.

• Case Studies • Viewpoints

Tool Type

Software

• Determine efficiency of branches using ML algorithm

• Automate common tasks or provide specific capabilities

• BranchScape• ScenarioFrontier• ECAPLeader• Web-enabled process baselining• Process mapping

Techniques

• Quantitative and qualitative techniques that can be used to conduct specific analyses

• Workout• Agile• Smart Customization• Spans and layers analysis

• Process mapping• Activity based costing• Value analysis• Workflow modeling

Templates

• Standardized or semi-custom forms that can be used to drive consistency across teams

• Process baselining templates• Workload & performance

driver templates• Visioning templates• PMO templates and tools

• Business case schedules• Best practice/benchmarking

templates• Capability mapping templates• Balanced Scorecard templates

• Business Process Redesign Framework• Prioritization• Benchmarking & best practice identification• Process modeling and blueprint creation• Business case development

Proven Methodologiesand Frameworks

• Approaches and Toolkits that can be used to work through types of problems or tasks

• Merger Integration• Modular Product Architecture• Tailored Business Streams• Customer Segmentation

methodology

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Agenda

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• Falling interest rates present both an opportunity and a dilemma for deposit bankers

• While banks should take the opportunity for significant down pricing, they need to approach with caution

• Most banks, facing a revenue shortfall compared to budgets anticipated rate increases (pre-COVID) are feeling compelled to take a meat-cleaver approach to downward betas. While this action appears on the surface to maximize margin, it conflicts with typical portfolio dynamics and runs counter to analytics trends in deposit management

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Content



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Key Benefits

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Understanding the value of deposits

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• The rate driven market is not standing still but rather evolving rapidly – Rate competitors are increasing their sophisticationo Banks are increasingly competing with rate – there is pressure on the credit

unions to compete• Cash flow prediction challenge

o What’s been the result of rate-based competition?o Did we convert variable rate customers?

• Cost of funding challengeo What is our cost of funding/deposits?o Are there any benchmarks that we can use?o What is the dynamic of our interest rate contingent cash flows?

• Deposit characterization, funding strategy and Funds Transfer Pricing (FTP) are the means by which this value is understood, realized and communicated

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Deposits have a different value across institutions Banks’ balance sheets can fall into two general business models

§ High level of assets securitization

§ External funding primarily supports the franchise

§ Diverse revenue model

§ Larger and more actively managed investment portfolio

§ Mainly reliant on deposits for funding § External funding (HQLA) provides

buffer for liquidity needs § Reliant on securitization§ Less diversified revenue model§ Smaller investment portfolio

Assets-Led

Deposits-Led

DescriptionBusiness Models

Note: Liability-led banks are defined as those with a higher Deposits to Deposits plus Borrowings ratio compared to other banks

Source: Bankscope YE 2019, Company Annual Reports, BBA Analysis

Assets Liabilities

Assets

Deposits funding

Equity

External funding

Loans

Investmentportfolio

Liabilities

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Overnight repo rate

4,34

3,044

0,4220,584

0,996 1,00 1,01 1,00

0,655 0,63 0,601

1,400

1,75

0,58

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

4,00

4,50

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Canadian Overnight Repo Rate Average (CORRA)

Source: Bank of Canada

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Low interest rate spreads

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4,02%

3,23%

2,30%2,40%

2,53% 2,52% 2,45% 2,45%

2,70%2,60% 2,60% 2,60%

2,40%2,20%

0,00%

0,50%

1,00%

1,50%

2,00%

2,50%

3,00%

3,50%

4,00%

4,50%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Canadian interest rate spreads

Average Canadian interest rate spread (lending rate minus deposit rate, %)continues to decline (c. 2.2 % in 2020)


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Deposits play an important role in ensuring compliance

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Net Cumulative Cash Flow

Net Stable Funding Ratio

Liquidity Coverage

Ratio

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Financing of business activities is fundamental to effective functioning

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32%

29%

15%

12%

4%3% 2% 2% 1%

Senior unsecured medium-term andstructured notes

Bearer deposit notes, commercial paperand certificates of deposit

Covered bonds/asset-backed securities

Mortgage securitization

Subordinated liabilities

Deposits from banks

Asset-backed commercial paper

Other

Credit card receivables and term asset-backed securitization

Funding instruments deployed by Big 6

For small to mid-sized financial institutions reliance on Retail and Commercial deposits remains high


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Classification of Canadian deposit liabilities

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0

200.000

400.000

600.000

800.000

1.000.000

1.200.000

1.400.000

2000Q1

2000Q3

2001Q1

2001Q3

2002Q1

2002Q3

2003Q1

2003Q3

2004Q1

2004Q3

2005Q1

2005Q3

2006Q1

2006Q3

2007Q1

2007Q3

2008Q1

2008Q3

2009Q1

2009Q3

2010Q1

2010Q3

2011Q1

2011Q3

2012Q1

2012Q3

2013Q1

2013Q3

2014Q1

2014Q3

2015Q1

2015Q3

2016Q1

2016Q3

2017Q1

2017Q3

2018Q1

2018Q3

2019Q1

2019Q3

Demand Term

Quarter-end, million of dollars


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Challenge with deposits volatility

The good news: The bank has not experienced a severe loss of deposits

The bad news: The historical observations tell us NOTHING about a future environment

-10.000

-8.000

-6.000

-4.000

-2.000

0

2.000

4.000

6.000

8.000

10.000

Red lines indicate 2 SD

Monthly Deposit Growth

Trendline

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Analytics trends in deposit management

Observations

• The traditional view of remixing the balance sheet has generally focused on the asset side, but it is deposits that are the primary driver of value on the balance sheet

• More sophisticated analytics around deposits can create value on two levels

o ‘Macro’ level of better understanding behavior of deposit products and incorporating that into ALM

o ‘Micro’ level of segmenting customers and incorporating improved analytics to better inform product pricing and strategy

• Key questions to be answered

o What portion of our balances can be considered stable & long-term?

o How do balances decay and how can I invest them?

o How do we invest to match deposit pricing and stabilize earnings?

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Content



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Key Benefits

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Analytics to consider

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• Funds transfer pricing (FTP) is a mechanism for calculating net income at a lower level than the entire bank/credit union

• FTP is a way to calculate net interest income by business line and product or by other management components

• FTP is an absolutely critical component of any risk-based performance measurement system as it ensures that risks are accounted for in the proper business units

• Balance: Develop core/volatile analysis• Rates: Use spread-adjusted swap curve for balance discounting• Develop replicating portfolio/proxy portfolio that maps cash flows with canonical fixed income

instruments• Determine interest rate sensitivity and duration• Lacks path dependencies which are often required to embedded options and for interest rate sensitive

balance modeling

Transfer pricing

Core/volatile analysis

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Key deposit metrics

VolatileRate-SensitiveCore

67% core & 7% rate sensitive @ 99.9% confidence

Volatile

80% core @ 99.9% confidence

Core

81% core @ 99.9% confidence

Core

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40

60

80

100

120

140

160

1 11 21 31 41 5140

60

80

100

120

140

160

1 11 21 31 41 51

Most large banks regularly update statistical approaches to improve their understanding of “core deposits” for ALM and liquidity

85% confidence interval (92% of balances)


Example: “Core” balances with low volatility Example: “Core” balances with high volatility

Average balance = $116



Source: Industry discussions, BBA analysis

Time (months)

Bal

ance

($)

Time (months)

Bal

ance

($)

Average balance = $116

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Live Poll: What percentage of deposits are considered ‘core’ at your institution?

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What is the split of retail demand deposits at your institution in terms of short term (i.e., less than 2 years) and long term (i.e., great than 2 years)?

1. 3% short term and 97% long term2. 8% short term and 92% long term 3. 5% short term and 95% long term 4. Others, specify

What is the split of retail savings deposits at your institution in terms of short term (i.e., less than 2 years) and long term (i.e., great than 2 years)?

1. 3% short term and 97% long term2. 8% short term and 92% long term 3. 5% short term and 95% long term 4. Others, specify

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FTP curves can be constructed in a number of ways, differentiated across two dimensions

Base curve Spread Liquidity premium

Cost of funds: A curve reflecting the Bank’s cost of funding itself in the wholesale market at various maturities

Bid/Ask: The FTP curve includes a market-based Bid/Ask spread. Treasury funds loans based on the Ask rate (while rates are paid to the deposit side at the Bid)

Liquidity premium: A premium is added to the transfer price to reflect liquidity benefit from products that have a maturity greater than their repricing frequency or from assets that have more/less market liquidity

LIBOR/Swap: A curve based on LIBOR for maturities under one year, and swap rates for longer maturities. This curve may be adjusted to reflect the credit quality of the institution

Allocated cost: A single value (e.g. Bid/Ask midpoint) is used to construct the FTP curve, with a small fee included (either through cost allocation or an addition to FTP) to cover Treasury’s cost of providing funding services

No liquidity premium: No premium added

No spread: The FTP curve is based on a single value, with no additional “fee”

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A framework for deposit valuation and success in building a better rate driven model

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Begin to enter new moneyUse replicating portfolio

analysis to optimize existing balances

Get the basic characterization correct

“Last time we checked they looked like x”

“High yield savings account is 3M money” “If they can do it, we can do it”From:

The rate has changed, has the behavior of our deposits?• Treasury: FTP +

Characterization• Technology

Using high yield balances to fund assets further up the curve can reduce volatility and increases earnings • Approach incorporates the lag

and dampening effects of rising rates

• Experience: 75 bps increase in margin, 50% reduction in volatility

To: We’ve committed to entering this business• Invest like a standalone

business• Pilot • Models development

How do we do this without information? • Many deposit portfolios now

include a lot of money that doesn’t behave like it used to

• No data to calculate the characterization

• Competitive environment is different

How do we make this impact the bottom line? • Characterization alone does not

create value • Must integrate into investment

strategy and FTP • How do we change existing

investments/credit?

Issues: What is the end-state?• The opportunity exists from

banks lagging and dampening rates as they change

• As competition increases the opportunity for this likely decreases

Tactical Mid-term Strategic

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Cost of deposits and liquidityA framework for valuation and success in building a reliable pool of liquidity

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Adjust the balance sheet to maximize value

Increase deposit flow over timeBuild deposits quickly

Tactical

“Price higher, we need funds”Value of deposits ~ variable to

fixedLimit reliance on Securitization, focus on increase in deposits From:

Ensure the right business decisions are made• Business unit is motivated by

the right cost of deposits• Treasury understands the real

cost of pricing up (mispricing risk)

Value of deposits = The real cost of borrowing• What is your risk profile?• Mapping the cost of deposits

to a Credit Default Swap curve

To: Optimize separate businesses• Focus on core business• Manage attrition/run-offs

How do we do this quickly without tools?• An elevated cost of funds faces

intermediation inefficiency

How do we manage?• Business line reporting relies

on FTP – it can not necessarily be adjusted ad-hoc

Issues: Optimize deposits coverage of loans• Equity efficiency demands

deposits and loans come together

• Eventually the execution must support managing to a cohesive business

Mid-term Strategic

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Applying more ‘micro’ approaches can lead to valuable insights that result in improved deposit pricing and strategy

n Moving to a more ‘micro’ balance modelling approach can provide additional insights into deposit behaviour– Several different segmentations of

customer are possibleo Balance tier o Demographico Separate markets

n Understanding the sensitivities of these segments to market factors will drive deposit valuation– Different price elasticity will drive

different pricing strategies

Example: Tiered pricing and customer behaviour in saving products

0,0

0,5

1,0

1,5

2,0

2,5

Jul 1

8

Sep

18

Nov

18

Jan

19

Mar

19

May

19

Jul 1

9

Sep

19

Nov

19

Jan

20

$25-50K balance tier displays significant rate price sensitivity

and balance run-off

<$25K balance tier displays no price-elasticity and behaves like a

traditional checking product

Rate (%)

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Copyright © 2020 BB Analytics

+1-905-499-3618 extn. 700

[email protected] Bba.to

DisclaimerBankingBook Analytics (BBA) is incorporated under the Laws of Canada, Canadian Corporation #: 990862-5, US Employer Identification #: 98-1260328. The information, data and approaches provided herein are an outcome of our research and content expertise. Although we may refer to third party materials and/or analyze their impact, the content is the outcome of BBA’s proprietary knowledge and is rightfully owned by us. This work is copyright protected and legally privileged.Please do not distribute this presentation without the prior written consent of BBA or its authorized affiliates.BankingBook Analytics has made best efforts to ensure that this material is complete in its entirety. However, we do not warrant its completeness, accuracy, usefulness or satisfaction with all requirements.

BankingBook Analytics, Inc.

The Exchange Tower, 130 King Street West, Suite 1800, Toronto M5X 1E3 Canada

Maximizing Deposit Margin and Growth In Low RateEnvironment

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