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FHLB Des Moines and Darling Consulting Group

Current Issues in Liquidity ManagementThursday, August 8th │ 3:00 PM CT

Examine key business issues and trends to help defend your liquidity position, understand key requirements of a comprehensive liquidity management system and learn why your management strategy and philosophy are crucial.

Wholesale Funding: Perception Versus RealityThursday, August 15th │ 3:00 PM CT

In today's economy, consider how wholesale funding can support your earnings challenges and develop a meaningful and cost-effective funding game plan to support the growth of your institution.

www.fhlbdm.com/products-services/advances/2019-funding-products-webinar-series

2019 LEADERSHIP SUMMIT

OCTOBER 16-18, 2019JW MARRIOTT MALL OF AMERICA │MINNEAPOLIS, MN

Register Now: www.fhlbdm.com/leadership-summit

� Risk Management Strategy & Solutions �

© 2019 Darling Consulting Group, Inc. • 260 Merrimac Street • Newburyport, MA 01950 • Tel: 978.463.0400 • DarlingConsulting.com

Current Issues in Liquidity ManagementFHLB Des Moines Webinar

August 8, 2019

Bob Lallo, Managing [email protected]

© 2019 Darling Consulting Group, Inc. Page 4

Definition

The Ability to Raise Money Quickly,

Without Principal Loss

At a Reasonable

CostLiquidity


Liquidity – Where Do We Start?


First…Addressing Regulatory Concerns

“The declining liquid asset cushions and increased use of potentially non-stable liquidity sources…suggest that small banks as a group are increasing their liquidity risk profiles…” – FDIC Supervisory Insights, Summer 2017


First…Addressing Regulatory Concerns

Loan growth continues to outpace deposit growth

Banks have shifted cash flows from investments into loans

2008Q3

2009Q1

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2015Q1

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2018Q3

60657075808590

Loans/Deposits

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2009Q1

2009Q3

2010Q1

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2011Q1

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2012Q1

2012Q3

2013Q1

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45474951535557

Loans/Assets

© 2019 Darling Consulting Group, Inc. Page 8© 2019 Darling Consulting Group, Inc. Page 8

Continuation of the Liquidity Dilemma

• Loan growth outpacing deposits• Deposit pricing pressures (Flat/Inverted Yield curve)•Wholesale funding levels increasing

• On-balance sheet liquidity under pressure• Use of “potential volatile liabilities” PVL - funding sources causing concern

Industry Headwinds

• Deposit concentrations/Wholesale concentrations• Identify “at-risk” deposits• Understand and manage deposit attrition

Regulatory Concerns

• NOT a regulatory compliance exercise• Stresses that fit your bank• Remediation plans a must

Deposit Stability and Liquidity

Stress Testing


Liquidity Management: 5 Areas of Focus

1. Identify Your Liquid Asset Cushion

2. Quantify and Assess Potentially Volatile Funding “PVL”

3. Revitalize Your Risk Monitor

4. Develop a Dynamic Forecast & Stress Test Framework

5. Deposit Strategies to Improve Liquidity


Identify Your Liquid Asset CushionIdentify Your Liquid Asset Cushion


On-Balance Sheet Liquidity

Tight On-Balance Sheet LiquidityStrong On-Balance Sheet Liquidity


Total Liquidity Position

Reserve based on concentrations

Available borrowing capacity vs. wholesale reliance

Brokered capacity


Strategy Considerations

u Keep cash to work – Fully Invested in Investments/Loans

u Identify ability to shift liquidity into loans

u Consider more of a defensive deposit strategy

u Maximize current FHLB & alternative funding sources

If “stronger” liquid assets then consider:

u Define liquid asset cushion

u May have to be more offensive in deposit pricing strategies

u Consider alternative pledging options (FHLB/ICS)

u Maximize current FHLB & alternative funding sources

u Defend with “Total” liquidity

If “tighter” liquid assets then consider:


Maximize Liquidity Yield – Keep Cash Invested


Quantify and Assess Potentially Volatile Funding “PVL”


Funding Types & Potential Risk:

• FHLB Advances• Brokered Deposits• Listing Services Deposits• Municipal Deposits• High Rate Deposits (based on national rate cap)• Uninsured Deposits • Single Source Concentrations (depositors that control 2% of total

deposits)

Regulatory Concerns


Product National Rate Rate Cap

Savings 0.10 0.85

Checking 0.06 0.81

MMDA 0.18 0.93

6M CD 0.39 1.15

12M CD 0.66 1.33

24M CD 0.84 1.52

36M CD 1.00 1.64


Savings 0.06 0.81

Checking 0.04 0.79

MMDA 0.09 0.84

6M CD 0.17 0.92

12M CD 0.29 1.04

24M CD 0.44 1.19

36M CD 0.59 1.34


Savings 0.06 0.81

Checking 0.04 0.79

MMDA 0.08 0.83

6M CD 0.13 0.88

12M CD 0.22 0.97

24M CD 0.36 1.11

36M CD 0.49 1.24

Regulatory Concerns: High Rate Deposits

December 2016 December 2017 July 2019

Fed Funds: .75%

FHLB 1 Year: 1.15%

Brokered CD 1 Year: 1.10%

1.50%

2.05%

1.90%

2.50%

2.02%

2.10%


Regulatory Concerns: High Rate Deposits

Standard

q FIL-25-2009

q …"a simple average of rates paid by all insured depository institutions and branches for which data are available."

q …presumption that the prevailing rate in all market areas is the FDIC-defined national rate.

q An institution not choosing to use the national rate can define its market area and support its position to the FDIC that prevailing rates in that area exceed the national average.

FDIC National Rate Cap 7/22/19

Page 19Page 19© 2019 Darling Consulting Group, Inc.© 2019 Darling Consulting Group, Inc. Page 19

High Rate Deposit – National Rate Caps: NMD

u $186MM or 21% of NMDs (on Deposits360°®) above National Rate Caps


Other Potentially Volatile – Large Balances & Uninsured Deposits

$609MM of deposit balances reside in relationships with over $250k.

• Includes 29 public entities

Approximately $449MM of uninsured deposits if assumed to remove $250k FDIC coverage from each relationship balance.


Other Potentially Volatile – 2% of Total Deposits

Total Deposits = $1.03B• 2% of deposits = $20.5MM

Relationships Controlling 2% of Deposits = 1

Top 10 = $102MM or 10% of Total Deposits

Top 10 Deposit Relationships


Large Balance Relationship Analysis: NMDs

Out of the NMD balances that reside in relationships over $250k ($538MM):• 72% of balances have 2 or more accounts per relationship• 56% of balances have been opened for 5 years or more

72%


Potentially Unstable NMD Large Balances

$99MM (11% of total NMDs) meet all 3 of the following:• Over $250k total deposit balance• Single Deposit Relationship• Less than 5 year relationship


Example: Concentration Analysis

Single Source Funding Concentration & Potentially Volatile Funding History

12/31/2018 9/30/2018 6/30/2018 3/31/2018

Concentration Thresholds Balance % of Assets Balance % of Assets Balance % of Assets Balance % of Assets

10% of Total Assets 0.0% 0.0% 0.0% 0.0%25% of Total Assets 0.0% 0.0% 0.0% 0.0%2% of Total Deposits 0.0% 0.0% 0.0% 0.0%

Funding Concentrations > 10% of Total Assets

Single Retail / Commercial Deposits 0.0% 0.0% 0.0% 0.0%Public Funds 0.0% 0.0% 0.0% 0.0%Secured Retail Repurchase Agreements 0.0% 0.0% 0.0% 0.0%FHLB & Other Borrowings 0.0% 0.0% 0.0% 0.0%

Other 0.0% 0.0% 0.0% 0.0%Total Funding Sources > 10% of Total Assets 0 0.0% 0 0.0% 0 0.0% 0 0.0%

Potentially Volatile Funding Sources

Brokered Deposits 0.0% 0.0% 0.0% 0.0%NMD with rates over FDIC Nat'l Avg +75bps 0.0% 0.0% 0.0% 0.0%TD with rates over FDIC Nat'l Avg +75bps 0.0% 0.0% 0.0% 0.0%Internet Listing Deposits 0.0% 0.0% 0.0% 0.0%Retail / Commercial Deposits >2% of Deposits 0.0% 0.0% 0.0% 0.0%Uninsured Public Funds (Amount over $250k) 0.0% 0.0% 0.0% 0.0%Uninsured Retail / Commercial Deposits 0.0% 0.0% 0.0% 0.0%Secured Retail Repurchase Agreements 0.0% 0.0% 0.0% 0.0%

FHLB & Other Borrowings 0.0% 0.0% 0.0% 0.0%Total Potentially Volatile Funding Sources 0 0.0% 0 0.0% 0 0.0% 0 0.0%


Example: Concentration Analysis


PVL Analysis – Now What?

How does the more “at-risk” level of your analysis compare to:

• Liquidity Contingency Deposit Run-Off• On Balance Sheet Liquidity• Total Basic Surplus operating contingency reserves

Think of PVL assessment like building a Loan Loss Reserve analysis for Large or At Risk Deposits


Revitalize Your Risk Monitor


Key Elements of Liquidity Risk Monitoring

Key warning signals or risk indicators (“triggers”)

Should be institution specific and meaningful

Match to operating activities and philosophies

Management should take into consideration both local, regional, and national market elements

Be commensurate with complexity of balance sheet/risk profile


Liquidity Risk Monitor: Qualitative Indicators


Revisit Your Risk Monitor


Management Response

Potential volatile liabilities have increased to 29% and have triggered Risk Level 1.

Management has applied a low stress level response as the total liquidity position (on-balance sheet as well as access to wholesale funding) remains strong. Additionally, the high concentration of volatile deposits have been analyzed and defended based on the strong core relationship with the customers.

Management will closely monitor changes to liquidity levels moving forward.


Develop a Dynamic Forecast & Stress-Test Framework


•Collateral values•Deposit Runoff, and/or Loan Losses •Below well-capitalized (low probability/high risk)

• Loan growth > deposit growth•Higher wholesale levels• Lower bond values

Economic

•Funding concentrations (PVLs)• ICS/CDARs• Loan concentrations

Rising Rates

• Industry specific•Environmental threats

Bank-Specific

Regional

Liquidity Stress Testing


Observations from Crisis – Stability of Funding Sources

On Balance Sheet

• Bond liquidity and selling at wrong time w/ losses a big deal

•Need multiple outlets for accessing cash w/ collateral

•Haircuts will increase in times of need

FHLB

• Largely stood by members in need

• Lines trimmed/haircuts on collateral/term restrictions

•Delivery of collateral

Brokered

• IDC rating scale of 1-300 seemed to affect pricing

• If a “1” and well capitalized, window was open

CDARS

• IDC data feeds internal risk assessment model

• Reciprocal deposit business not immediately pulled from participants

• Issue is brokered deposit restriction/waiver process

National/Internet CDs

• Kept banks afloat long after brokered was pulled by regulators

• Issue is brokered restriction on rate, and high rate market

Considerations in Building in Your Liquidity Stress


Dynamic Liquidity Forecast

Source: Liquidity360°®

$40MM loan growth$34MM deposit growth


Liquidity Stress Testing & Key Components

Deposit runoff (from study)Increased haircuts (last crisis)

Remove unsecured funding lines How long until we feel the pressure?

Moderate Stress Scenario


Liquidity Stress Testing & Key ComponentsSevere Stress Scenario

Severe Stress Scenario Remediation Plan


Five Steps to an Effective Contingency Funding Plan “CFP”

Risk Monitoring

System

Formulate “The Plan”

Develop a 1-2 Year Cash

Flow ForecastStress Test

Remediation Plan


Deposit Strategies to Improve Liquidity


Lending & Deposit Observations(Some Variations By Market)

Lending: Flat to Inverted Yield Curve & Lower Term Rates

• Loan pricing under downward pressure for many (Before 25-50bp)• Elevated “non-rate” based competition: terms & conditions• More banks “walking away from deals”• Loan growth outlook dampened for most• Longer term assets to help reduce Asset Sensitivity (Declining Rates)

Deposits: Higher Short Rates & Accelerating Pricing Pressures

• Slowing growth rates & increased disintermediation• More negotiations…and at higher interest rates• Increased incidence of “Specials” (CDs & MMDA)

• BUT, KEY ISSUE: “What will happen if the FRB begins to cut?”


Three Critical Questions

1. How Much Liquidity Do We Have?

2. How Much Liquidity Do We Need?






90-Day Liquidity Forecast

How do we fund loan growth?

u Raise deposit rates?u New product/market initiative?u Use Investment cashflow?u Draw down on wholesale?

Net Loan Growth $10MM

Net Deposit Flows $0MM

Net Cash Flow $-10MM

Cash/Investment Cash Flow Due $5MM

Wholesale Funding Maturities $5MM

Net Loan Growth $0MM

Net Deposit Flows $0MM

Net Cash Flow $0MM

Cash/Investment Cash Flow Due $10MM

Wholesale Funding Maturities $5MM

How do handle the investment cashflow?

u Re-invest at current rates?u Payoff wholesale maturities?u If not, how long to renew wholesaleu What about Deposit pricing pressures?

v One-off’s, let leave, price up

Defensive Deposit Strategy Offensive Deposit Strategy?




3. How Much Do We Want to Pay?



Industry Rate Trends (Interest-Bearing Deposits)

Even If Fed Is Done Raising Rates, Will Deposit Pricing Pressure Continue Through 2019?

?


Deposit Strategy Discussions

Offensive or Defensive strategy?

Discuss potential hurdles• Explore all options• Discuss new money initiatives and how to roll out• Minimum balance• Relationship-based pricing

Marketing efforts more focused in specific markets

Front line sales training


Deposit Initiatives: Understanding Your Customers

1. Banking model for top 100 / 200 customers…..2. Identify “at-risk” customers3. Identify opportunities within…direct marketing programs 4. Track new money vs. cannibalization5. High Share vs. Low Share6. Specials Rates vs. Rack Rates7. Single Relationships 8. Revisit MMDA tier structure9. Tracking of Closed/Lower Balance 10. Branch structure/“E” Banks 11. Are we asking? 20

15Q4

2016Q1

2016Q2

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2017Q2

2017Q3

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2018Q3

0.15

0.25

0.35

0.45

0.55

0.65

0.75

0.85

Cost of Interest Bearing Deposits


Understanding the Cost of Cannibalization

Source: Deposits360°®







Identify Single Source Customers



Relationship – Declining Balances



Key Takeaways

1. Identify Your Liquid Asset Cushion

2. Do Your Homework on PVL Concentrations

3. Revitalize Your Risk Monitor

4. Develop a Dynamic Forecast & Stress Test Framework

5. Deposit Strategies to Improve Liquidity


Can You “Tell” Your Story?

Can you explain your actions • What are you doing?• Why?• How?

Discussions / Committee(s) / Documentation


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Documents