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Echo Partners Community Bank Blog

    7 Steps to Deposit Study Success

    BankVaultIt's no secret that regulators have been focused on bank-specific assumptions, particularly deposit assumptions.  It's also no secret that the most inquiries and questions that I get concern deposit study issues.

    Please join me for a webinar "7 Steps to Deposit Study Success" on Friday November 21 at 3pm ET where I will uncover and explore the steps involved in creating an accurate deposit study, acceptable to your regulator.

    All attendees will recieve a copy of my 7 Steps to Deposit Study Success roadmap.  Click here to register

    Topics covered will include data prep, decay, beta, surge and extracting asset liability inputs from the study results. 

    This training webinar is suitable for all community banks investigating deposit study methodologies.

    There are really only 2 types of banks right now:  Those who have been told by their regulator to get bank-specific deposit assumptions, and those who are going to be told by their regulator to get bank-specific deposit assumptions.

    Take this first step to get in front of this important issue now.

    All attendees will recieve a copy of my 7 Steps to Deposit Study Success roadmap.  Click here to register


    Photo provided by Ishmael Orendain

    FDIC Issues Community Bank Regulatory Update

    TestifyOn September 16 Doreen Eberley, Director of the FDIC Division of Risk Management Supervision, testified on the status of community banks to the Senate Committee on Banking, Housing and Urban Affairs.  You can read the full text here.

    Here are a few highlights on the importance of community banks:

    • While accounting for only 14% of industry assets, community banks account for 45% of all small loans to businesses and farms.
    • Almost 20% of all U.S. counties would have no physical banking presence at all if not for community banks.

    And a few updates (most obvious to us) about community bank financial performance:

    • Net interest income has been squeezed.
    • Regulatory expenses have increased.
    • Traditional community banks (relationship lending funded by stable core deposits) performed well during the banking crisis
    • Fast growth, risky assets and volatile funding were associated with higher rates of failure.

    Current financial performance illustrates these points:

    • Community bank loan balances grew 7.6% in the past year, outpacing the 4.9% industry growth.
    • Over 75% of increase in small loans to business was driven by C&I and nonfarm, nonresidential RE loans.
    • Community bank NIM was 3.61%, 46bps above the industry average.
    • Noninterest income and noninterest expense were both down at community banks.
    • Community bank profitability increased 3.5%, less than the industry overall 5.3% growth.
    • Over half (57.5%) of community banks reported higher earnings than a year ago
    • Community banks experiencing losses fell to 7.0% from 8.4% of all community banks

    The community bank supervisory approach was also discussed.  The FDIC emphasized that they tailor the supervisory approach to the size, complexity and risk profile of each bank, using the following factors:

    • Pre-examination planning
    • Extended safety and soundness examination intervals (over half community banks on 18 month schedule)
    • Off-site monitoring and early warning associated with rapid loan growth and unusual levels or trends in...
    1. Problem loans
    2. Investment activities
    3. Funding strategies
    4. Earnings structure
    5. Capital levels

    I'd encourage you to give it a read and to send a note to your Senator (and House members too) letting them know how you feel.

    Fed President: Tailor Community Bank Regulation to Risks

    speechComments on community bank performance and regulation by Minneapolis Fed President Narayana Kocherlakota should be reviewed by all interested in community banking.  Read the speech here.

    Kocherlakota makes 4 main points on the state of community banking.

    1. Community bank recovery in asset quality has been strong.

    2. Lagging earnings and loan growth raise questions about the cost of new and enhanced regulation.

    3. Low earnings combined with higher compliance costs raise concerns about community bank consolidation.

    4. As a matter of public policy Kocherlakota supports tailoring supervision and regulation to reflects the risks and roles of community banks.

    Kocherlakota goes further and offers two specific ways regulation could be further tailored in the future.

    1. Congress and supervisors should exempt all community banks from certain regulations.  In fact, he goes so far as to state that "Exempting is the best way to guard against regulatory trickle-down."

    2. Narrow the focus of current supervisory methods that are too detailed across too many areas and apply to too many banks.  

    Instead, he suggests that regulators concentrate on the small handful of activities that are correlated with bad results.

    • Rapid loan growth.

    • High lending concentrations

    • Specific high-risk types of lending.

    • Specific wholesale funding strategies

    These types of common sense approaches to overly severe regulation should be supported by all community bankers. In our society, the way we make our support known is through our elected officials.

    Please call on your representatives to support even handed community bank regulation that focuses on actual risks associated with community banking, and not on nontraditional activities that larger TBTF banks pursue.



    Photo provided by Joseph Friedrich

    3 Deposit Study Secrets: What If You Don't Have Data?

    Tell SecretsHere's the one thing you need to know:  You can get a valid deposit study even if you don't have the data on hand.

    Thanks to a change in regulatory priorities, I now get more questions about deposit studies than any other topic.  And one that just keeps coming up is "What do I do if I don't have the data?"

    If this is you, I've got good news.  You may need to have someone at the bank do a bit of grunt work, but I will show you how to recover sufficient data to complete a basic deposit study. 

    I recently spoke with a banker that was getting some regulatory pressure to develop a bank-specific deposit study to support their NMDA assumptions in their interest rate risk model.  The bank has been around for several decades so I expected they would have all the data needed in a nice neat IT report or extract from their core system.

    There was just one problem.  The bank had done a core conversion in 2012 and failed to keep the old data.  This is a very common problem. I see this all the time.

    The bank thought they were out of luck.  In reality, they just needed to look at the situation differently.

    As bankers, we've been trained to be decision makers.  And the way that happens is that we associate certain behaviors or circumstances with particular outcomes.  Using this frame of reference allows us to quickly make decisions based on our experiences.

    Typically, that's a good thing.  But it can also blind us to alternative solutions.

    The way this trait shows up with deposit studies is that if we are familiar with them at all, it's usually from the perspective of having heard or experienced what I call a static pool deposit study. 

    Static pool relies upon tracking the ongoing changes in the same specific individual accounts (the "static pool").  These changes are tracked, for these select individual deposit accounts, month after month, year after year.  This is done to develop a simple model of the lifecycle of your NMDAs.

    So based upon the static pool, we need lots of IT help, monthly data and risk exposing the bank to privacy issues based upon individually identifiable accounts.  Plus we run the risk of tracking the wrong account vintage years and ending up with a bad study.

    The dynamic pool method, on the other hand, uses the change in all existing balances to derive the decay rate associated with your NMDA account balances. It has the advantages of being easy to calculate and understand, does not require extremely difficult IT extracts, and does not involve personally identifiable account information, so privacy concerns are minimized.

    And best of all, it lets us use a different data approach to creating our deposit study.

    The first secret to this approach is all about statistical significance and how we analyze our data.  Here's the rule of thumb that it will all pivot upon:

    You typically need about 55 data points to get a statistically significant result.  

    As the data points increase, our statistical relationships tend to strengthen.  And sometimes you get lucky and can obtain a valid set of relationships with fewer data points.

    That's a little more than 4.5 years with monthly data....But it's almost 14 years with quarterly data.

    Just keep in mind that data is data, whether it's daily, monthly, quarterly or annually. And statistics don't care if your data is in any of these periodic terms.  It simply needs some consistency in format.

    So here's the lucky break for all you community banks that are worried about not having your data.  It just so happens that FDIC and FFIEC retain all of your Call Reports that have been filed since 2001 online.  

    That's right, just exactly the number of quarterly data observations you need to be pretty much guaranteed to develop a statistically significant set of results.

    This is really great timing because even if you have no data on hand, you can use the old Call Reports to extract the line item level data needed to do a basic deposit study.  

    I understand that recovering this data is a mind-numbing menial task, but you can get it done, and it won't cost you a penny.  And it's better than facing your regulator with the news that you just won't be able to comply with their request for you to develop inhouse bank specific NMDA assumptions.  But keep reading for another big insight.

    The second big surprise is that you can mix and match data frequency.  

    So in the case of my community bank friend mentioned above, they have about 2 years of monthly data available via the new core system.  So all they need to do is to combine those 24 observations with about 7 years of quarterly data and voilà they have all the data they need.

    Finally, here's the third under-appreciated fact about deposit study modeling.  

    The data needed for modeling your decay rates (determining average life) is much less sensitive than the data needed for determining your beta (rate sensitivity) factors.

    So even if you have less that the "ideal" minimum of 55 data points, it's worth taking a look to see what the data tells us.  

    You may find that your smaller data set is sufficient to get you started with a basic deposit study.  Maybe you'll be able to only determine average life, but have less success with beta.  It's still progress.

    And the truth is you have to start somewhere, so why not here and now?

    If you're interested in learning more, please let me know.  Together we can overcome this challenge.




    Photo provided by Steven Depolo

    Bank Regulatory Trends in MRBA

    BankExamMatters Requiring Board Attention (MRBA) trends are a hot topic in the latest FDIC Supervisory Insights.  Read the full publication here.

    Over the period 2010 - 2013 the FDIC's MRBA comments on the Report of Examination (ROE) were collected, categorized and statistically aggregated.  This summary data forms the basis of the article.

    The most common areas ("Top 5") mentioned in MRBAs, along with key areas of specific mention, are listed below. Keep in mind these are typically for "1" or "2" rated institutions.

    1. Loans (Cited in 69% of all MRBAs)
    2. Board or Management (45%)
    3. Violations (24%)
    4. Earnings (24%)
    5. Interest Rate Risk (24%)

    Loans focused on credit administration, problem assets, ALLL deficiencies and concentrations.  Over the period of the study (2010 - 2013) the loan category has been declining in frequency, although it is still by far the most common category.

    Board / Management comments focused on policies, audit, strategic planning and succession planning.

    Violations typically involved appraisals and/or insider lending practices.

    Earnings is primarily concerned with strategies to safely improve earnings.

    Interest Rate Risk mentions have been on the rise since 2010.  This should be no surprise as numerous regulatory releases and attention since then have targeted interest rate risk.  Eventually rates will rise and your regulators' concerns will be realized.  The time to prepare is now.

    Generally, citations for interest rate risk have involved improved monitoring and control of the IRR process.

    Liquidity didn't make the "Top 5", but deeserved special mention for declining in importance over the period.  Again, as the crisis passes this is expected behavior.

    IT issues on the other hand were not in the "Top 5" but have increased in frequency over time.  Watch this emerging category.


    Photo provided by Images Money

    OCC Calls Out Community Banks on Economic Value of Equity Risk

    riskyWe wrap up our overview of the OCC Semiannual Risk Perspective report with a focus on economic value of equity (EVE) or long term interest rate risk.

    You can read our earlier comments here and here.

    With key concerns over longer duration assets and fear of increased rate sensitivity for non-maturity deposit accounts, it only makes sense to examine long term EVE interest rate risk.

    The OCC offers a chart of historical EVE performance (provided by Olson Research Associates) showing a subgroup of bank EVE exposure to a 200bps rate hike, ending in Q2 2013.  In Q2 the levels shown averaged a 24% reduction in EVE for a 200bp rate hike.

    Based upon my own proprietary interest rate risk model, calculated for all FDIC-insured banks nationwide, the average EVE risk for a 200bp rate hike at September 2013 was 22%.  

    Remember, that's the average EVE reduction.  

    The riskiest 20% of all FDIC-insured banks at September 2013 had an EVE risk exposure (reduction in economic equity) in a 200bps rate hike scenario of greater than 33%.

    How does your EVE risk compare?  

    Email or call me if you wish to discuss how to mitigate your risk exposures.



    Photo provided by Paxson Woelber.

    OCC Reiterates Community Bank Interest Rate Risk Concerns

    DoNotReadThe OCC's Fall 2013 Semiannual Risk Perspective sounds suspiciously similar to the FDIC's recent warnings.  Just in case you didn't read the FDIC warnings, or even if you did, take a look at the OCC's message.

     Download the OCC Semiannual Risk Perspectives report here.

    Part III of the report, "Funding, Liquidity and Interest Rate Risk" focuses on 3 familiar topics.

    1. Retention and pricing of deposits
    2. Investment portfolios
    3. Increased Economic Value of Equity (EVE) risk

    We will quickly work through the OCC's concerns in a short series of articles.  This article will feature the OCC's perspective on the retention and pricing of deposits.

    OCC is focused on the retention rate and pricing of deposits and feels they may well be much more rate sensitive than historical relationships would suggest.  Sound familiar?

    Recent OCC supervisory efforts have focused on deposit pricing and runoff assumptions in stressed rate environments.  

    OCC is specifically calling for community banks to establish methods to capture deposit behaviors so as to improve the accuracy of interest rate risk modeling.  

    In English, this means that they want you to implement some form of deposit study.  Call or email me for help with this task.

    One last point.  When OCC and FDIC are coordinated in their approach to a risk issue, I'd suggest that you better pay attention.  Because your regulators will be asking about these items very soon.



    Photo provided by Nicolas Raymond.

    FDIC Questions Non-Maturity Deposit Stability

    bankdepositPreviously we reviewed the FDIC's interest rate risk warning on long duration securities.  You can find more on this topic here and here.  Now we will examine FDIC's related concerns on non-maturity deposit accounts (NMDAs) with respect to interest rate risk.

    The FDIC correctly observes that banking has experienced a surge in deposits since 2008.  This surge has been pronounced enough to result in the highest growth rate in domestic deposits in over 15 years.  Please note that although community banks have also seen historic deposit growth, the bulk of the volume has been at the largest banks.

    Deposit mix has also changed markedly, especially at community banks, where noninterest bearing deposits (many NMDAs) have grown to the largest allocation in over 15 years.  At the same time, time deposits at community banks have fallen to a 15 year low (with the silver lining that the duration of remaining time deposits has grown and is now longer than in 2008).

    But don't forget this is good news for community banks.

    These noninterest bearing NMDAs offer opportunities for cross selling and fee revenues as well as improving NIM for community banks.  These no cost deposits have displaced some time deposits, as well as brokered deposits and FHLB advances.  

    Now, I'm a big believer in time deposits, brokered deposits, and FHLB advances, but for this part of the rate cycle, I'm all in favor of maximizing NIM when you can do so safely.  In fact, using NMDAs more now means that community banks can keep their powder dry on those other liquidity sources.  Sounds like good planning to me.

    So given all of these benefits, what's FDIC concerned about?  Really, it boils down to the "What ifs" of NMDAs.

    What if the reason these NMDA accounts have grown is related to today's low rate environment and rates start to move up?

    What if NMDAs have grown due to a temporary reduction in risk appetite and that returns?

    What if NMDAs are simply a low cost substitute for a lack of alternative investment opportunities?

    It all comes down to one simple regulatory risk management question:  What if non-maturity accounts behave differently in the future than they did in the past?  What if it's different this time?  What if they are less stable and are actually much more rate sensitive than we expect?

    The answer then becomes that banks may need to replace this funding (at higher rates) at the exact same time that their longer duration assets suffer their greatest depreciation.  Sounds like a double whammy to me.

    FDIC then adds salt to the wound by postulating that Dodd Frank Act (DFA) may make this even worse with the end of prohibitions on the payment of interest on demand deposits.  You know, banks get in a bidding war to keep NMDAs.

    So, what's a prudent community banker to do?  I think it boils down to 3 things.

    1. Expect increased scrutiny of your NMDA assumptions.
    2. Proactively improve your NMDA modeling process
    3. Run more frequent "What if" scenarios with your NMDA assumptions

    I have already seen increased regulatory emphasis on NMDA assumptions during the examination process.  Remember, it's always best to have bank-specific assumptions.  And that means a deposit study of some sort.  Email me for details on how we can make this a reality at your bank.

    Similarly, if you already have bank-specific NMDA assumptions, now is the time to revisit them for accuracy, documentation and robustness.  Having wrong or misleading NMDA assumptions can actually be worse than not having any at all.  

    Finally, now is a great time to run more frequent NMDA assumption sensitivity analyses.  Speed up your decay rate (shorter average life) and increase your beta (more rate sensitivity).  Having these sensitivity scenarios ready to show your regulator can go a long way in getting them comfortable with your NMDA and overall deposit funding mix.

    If you have questions, please email me at howard.lothrop@echopartners.com



    Photo provided by Jo Naylor.

    FDIC Sounds Interest Rate Warning on Long Duration Securities

    warningLast week the FDIC issued FIL-46-2013, titled Managing Sensitivity to Market Risk in a Challenging Interest Rate Environment.  You can see the FDIC release here, and download the actual FIL here.

    The FIL starts out as a general reminder of the importance of interest rate risk and asset liability management.  Here's the 2nd sentence in the FIL, a typical excerpt:

    "Nationally, a number of institutions report a significantly liability sensitive balance sheet position, meaning that a marked increase in interest rates could adversely affect net interest income and, in turn, earnings performance."

    Not wanting to beat around the bush, the FIL quickly turns and focuses on one specific area: the price risk associated with securities portfolio.  Here's the 3rd sentence...

    "For a number of FDIC-supervised institutions, the potential exists for material securities depreciation relative to capital in a rising interest rate environment."

    Now, just in case we miss the not-so-subtle message, here's a more direct statement buried all the way down in the 4th paragraph...

    "If interest rates were to rise markedly, institutions that have concentrated bond holdings in long-duration issues could experience severe depreciation of a magnitude that could be material relative to their capital position. Institutions that rely primarily on a long-duration fixed-income portfolio for liquidity could have difficulty meeting short-term cash needs if other marketable assets or funding sources are not readily available."

    It is notable that no other specific risk exposure or position is addressed in this FIL.

    It would be my considered professional opinion that anytime the FDIC openly warns banks that a single exposure poses a material threat to both capital and liquidity you had better start paying attention.

    And that means getting a grip on the duration of your bond portfolio.  Here's a quick piece of free consulting designed to help you manage this risk at your banks...Sell Your Longer Bonds.

    We all know the reality of the past few years of low loan demand low rates and squeezed earnings have put pressure on bankers to get more "creative" managing the balance sheet.

    It's no secret that many banks have bulked up the investment portfolio to help cushion the blow to earnings.  And, as with all things, some banks just didn't know when to stop.

    Understand, I am not suggesting a conscious effort by any bankers to purposefully add too much risk.  No, it's something much more insidious.

    Some fixed income shops market adding more risk via longer duration bonds as a sophisticated strategy to "improve" your portfolio.  They'll tell you:

    • It's more efficient.  
    • It's based on portfolio theory.  
    • It's educational.  
    • It's based on "the numbers".  
    • It's what the big successful portfolio managers are doing.

    And, over time, you're gently seduced by the pitch.  You see the results.  You hear the siren song of total return.  You start to convince yourself that the risk is all blown out of proportion.  And then they've got you.

    I have 2 problems with this.  First, you're running a bank and NOT a hedge fund or mutual fund.  It's all about the cash flows, and not total return.  Second, it ignores the purpose of a bank investment portfolio, which is to provide liquidity, not to build earnings.

    Now, to be fair, this FIL isn't titled "Long Duration Bonds are a Dangerous Exposure", so it would be reasonable to expect bond guys to spin this release another way.  

    They'll focus on the general warnings, issued to and applicable to all banks.  And that's all well and good.  But I've got a problem with this interpretation.  It just isn't supported by the facts.

    As many of you know, I calculate complete +/-400bps rate sensitivities on all FDIC-insured banks nationwide each quarter.  For June, 2013 that means 6,918 banks.

    So let's do things the "modern" way and get "analytical" and "educational".  After all, that's clearly what these total return bond guys have suggested you do.  But let's do it looking at the entire universe of FDIC-insured banks, and not just at 1 bond for 1 bank.

    Here's what I've uncovered.

    Gap:  Number of banks with gap worse than <25%> 

    Rates Up 200bps (approximate 50bp NIM compression) = 157 banks

    Rates Up 400bps (approximate 100bp NIM compression) = 173 banks


    Earnings at Risk (EaR):  Short term interest rate risk 

    Rates Up 200bps (12 month EaR)

    Number of banks with EaR worse than <20%> = 12 banks

    Rates Up 400bps (12 month EaR)

    Number of banks with EaR worse than <30%> = 57 banks


    Economic Value of Equity (EVE):  Long term interest rate risk 

    Rates Up 200bps 

    Number of banks with EVE worse than <25%> = 1,549 banks

    Rates Up 400bps 

    Number of banks with EVE worse than <45%> = 1,817 banks


    So here's the curious thing.  Why do so few banks demonstrate excessive risk using gap or EaR, while so many more banks exhibit this risk when we turn to EVE?

    The answer is that gap and EaR are looking at the 12 month time horizon window so that there isn't really sufficient time for your model to fully capture the earnings based impact of a significant rate hike.  

    And they're definitely not designed to capture the price risk of a total return approach.

    EVE, on the other hand, captures this risk precisely because it models the long term present value of asset and liability cash flows.  Sort of sounds like bond math, doesn't it?

    That's why the 2010 Joint Advisory on Interest Rate Risk prodded you to make sure you have multi-year EaR, and specified that all banks need to track EVE.  So these exposures don't creep up on you while you're not watching.

    And if you're going to drink the total return koolaid and go for a swim in the long duration pool you better make sure you adjust all of your interest rate risk models to capture this risk.  Because if you can't model these risks accurately and independently within your bank then you have no business taking these risks.

    One last point.  Now, maybe you're aware of these risks, but what about your Board?  It will be a very bad result if you fail to keep your Board posted on these risk exposures at your bank and these rate risk losses come home to roost.

    Because I've got a feeling that your examiners won't be cutting you very much slack if you get this one wrong.  Not after this warning.  

    Disclosure:  The interest rate risk sensitivities noted above are calculatd based upon Call Report information and the proprietary Echo Partners interest rate risk model.  Institutions may have hedging positions, or other assumptions and strategies that can moderate or change this calculated and reported sensitivity.  You must decide if this information is relevant to you and your bank. Actual mileage may vary.  


    Photo provided by Hugo-photography.

    S&P Downgrade Gets It Wrong; Bank Regulators Get It Right

    FlagAs we all know, S&P downgraded the US credit rating late Friday after the markets closed.  The long term rating was cut to AA+, while the short term rating was reaffirmed at the highest A1+ rating.  Here's a link to the S&P action.

    A Joint Policy Statement from the bank regulators reemphasized the zero risk weight status of U S Treasury obligations.  This is the right call.

    So, how did S&P get it wrong?  They simply mixed up the short term and the long term default risk.  The only risk of default is basically a short term political problem related to debt ceiling and spending restrictions.  So, the risk is actually in the short term.

    In the long term, as Alan Greenspan correctly noted on Sunday's "Meet The Press", we can always print more money to cover the debt.  Here are Greenspan's comments:

    "MR. GREGORY: Are U.S. Treasury bonds still safe to invest in?

    DR. GREENSPAN: Very much so. I think there's--this is not an issue of credit rating. The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default."

    And here is a link to the full transcript.  Greenspan's comments are about a third of the way into the transcript.

    Now, you and I may well disagree with the idea of simply priniting money.  I for one recognize that action as a tax on all of us through inflation.  So the market risk of U S Treasury debt may have increased.  But the fact remains that the actual default risk is still zero.

    So why did S&P drop the ball?  In my opinion, it's for the same reason that they dropped the ball on rating debt in the run up to the 2008 financial crisis...they are focused on something other than the actual creditworthiness of the debt.  In 2008 it was market share, now it's politics.  Probably a good thing to rid the bank regulations of ratings if this is what we're going to get.

    Photo provided by Dru Bloomfield.


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