In this episode of The Purposeful Banker, Alex Habet welcomes Andy Heusel to discuss how waking up the "sleepy money" of deposits has affected bank strategy.
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[Blog] Waking the Sleeping Giant of Deposit Pricing Strategy
[Blog] Why the Windshield Is Larger Than the Rearview Mirror
[June 7 Webinar] Chasing Deposits in a Liquidity Crisis
Transcript
Alex Habet
Hi, and welcome to the Purposeful Banker, the leading commercial banking podcast, brought to you by Q2 PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host, Alex Habet.
So we're back to our regularly scheduled programming, and by that I mean we're going to be talking about a lot of the stuff that's in the news these days again. So it's the beginning of May, probably trending, I guess, toward the middle of May at this point, but there's been a few additional major headlines in the banking business as you would expect. So we'll start with the big one, right? First Republic Bank is now part of JPMorgan Chase. Perhaps the chapter for that institution has more or less closed, but with another rate hike that just went through and several other vectors still out there in every direction, there's really no telling what else lurks and me, personally, I'm done trying to even predict, right?
But I will gladly share the mic with the voices of those who live through this stuff day in and day out and have an opinion to share with this audience here. Recently, a few blog posts went out from our team, and they've caught the attention of many, both internally to our company and also with our clients externally. There are a few people that are putting out content on a fairly regular basis, so I'd highly encourage you to be sure to check out the website precisionlender.com. You can find all our content posted there, but thought it'd be interesting to bring one of those perspectives into this episode today to provide a little bit of color. Think of this as a color commentary on top of these great blog posts to help you understand and see the bigger context here of what the story's trying to tell you. So I would like to welcome today Andy Heusel to give us that human voice behind some of those wonderful posts that recently went out. Andy, welcome to the Purposeful Banker.
Andy Heusel
Alex, thanks for having me. Happy to be here. As always, it's quite an interesting time to be in banking and be in the banking industry. We're both veteran bankers, and we've been through things both on the actual client side of the table being in the bank, and then now we get to see it from the other side where we're more on the consulting side. Obviously we have very powerful software that we offer our clients to deal with some of this stuff right now. So happy to be here and happy to elaborate on some of the blog posts.
Alex Habet
Yeah, again, thank you. Look, I've been told that you have been ... I've observed this directly, but I've also been told by others that, hey, you're having a lot of conversations these days with many of our clients in particular focusing on deposit strategies. It's the side that was not as much in focus in recent years. So it's obvious through the content and the tone of your writing that it is front and center. How, just by and large, how have those conversations been with some of the clients that you've been working with?
Andy Heusel
Yeah, so it's been obviously a complete 180 shift from focused on how do we grow loans. How can we be competitive in the market? Those kinds of things. So focused on the asset side of the balance sheet, it's completely shifted to the other side of the balance sheet. Obviously, there was so much liquidity in the market with all of ... After the pandemic started and things settled down. Of course, when the pandemic started, nobody really knew what was going to happen. The sky was kind of falling there for a little bit. Obviously, that didn't happen. Credit quality did not take a dive, and really there was just so much money in the market. Everybody knows the causes of that and the reasons for that. The banks sat there, and they just really weren't interested in deposits. They weren't paying for them. It was all about how do we get this money out the door for the last three years at a competitive rate.
Obviously, banks couldn't get a lot of that money out the door, and so they went long in the securities portfolio. And now with what we're seeing here with inflation, all the things that the Fed is doing to combat that actually hurt the banks really badly, with their securities portfolios. So it's a little interesting that the Fed tactics that are combating inflation are actually what are causing a lot of this issue with the banks. And then obviously all those outflows of money as things get more expensive, as companies made capital investments with the money not freely coming back into the market, liquidity has been challenged.
And so that's kind of where we are right now. Everybody's focused on gathering deposits, and so obviously the first thing you think about is, well, how much are you going to pay for them? And so we saw deposit betas were very low for a while. If you look at what's happened in '23, they've actually jumped way up, and that's really just the banks catching up with all of the previous Fed moves that we've seen in '22 and now into '23. So deposit pricing is getting very interesting right now.
Alex Habet
Would you say it's similar to the way gas prices work? When the price of oil goes up, you'll see that the gas stations will immediately put the price up, but then when the prices go back down, they take a long time to come back down. So we have kind of the inverse thing happening here with deposits, with interest rates going up, you kind of have this slow payout, but if rates, let's say hypothetically, were to go back down, they probably won't be so quick to drop those. They would be very quick to drop those deposit rates immediately, right?
Andy Heusel
Absolutely. And from experience, I can tell you what goes on in those ALCO meetings, those loan and deposit pricing committee meetings, obviously the bankers have their goals. Their goals are to grow both sides of the balance sheet. Hopefully they're focused on both sides of the balance sheet, but it usually goes like this, that the line guys are telling the CFO that, "Hey, we can't get deposits at this rate, you know, (you have) got to give us some room to negotiate." And the CFO digs his heels in, doesn't want to do it. So you get that back and forth. That constantly goes on.
Obviously banks have ... my opinion right now, though, is that the banks ... and to go back to the sleepy money topic, as a client, you and I probably have money sitting around and it wasn't earning much, and we could have gotten 25 basis points if we'd have moved it to the bank down the street, as we like to say. But too much work, not enough reward. So we didn't really worry about it.
When rates can now get 4%, 4.5% on a money market versus 50 basis points, you're going to be interested in that. So one of the strategies that hopefully banks saw is that realizing that money's going to move once, maybe twice, that sleepy money woke up and made that move. So banks that were quick to raise their rates, I think, should benefit in the long term, get that money that just woke up, wants to earn a little bit more, and hopefully that should bring in a client, potentially a new client obviously, that is going to stay around and they're probably not going to move that money again for another 25 basis points when the Fed makes its move.
So I think it's important to note that the first movers on actually paying up for deposits are probably going to benefit from new client growth in the long term versus the ones that are lagging. So that would've been my strategy if I was in the room kind of running that ALCO meeting knowing what we're going into.
Alex Habet
So look, I know it's unusual circumstances and recent memories that we're going through now, but is there any point dating back to your career in the banking days that this feels familiar, or is this just completely new, you think?
Andy Heusel
Well, I mean, again, I kind of think about this. I lived through Hurricane Katrina, and that was a big issue with the bank that I worked for, and we didn't know what was going to happen. Basically, our whole footprint had major damage, and you think about what happens after a hurricane. Everybody says, "I don't want to be on the beach." But after about 10 years, that memory starts to fade, and so everybody's back on the beach again. Banks go through a banking crisis, obviously the big one in 2008 that was more of a credit quality thing. I think this one is more of obviously what happened to Silicon Valley Bank and Signature was really a ... I don't call it a bank run, it was a sprint, and the liquidity was drained out of the bank instantly with all the technology that we have.
So that's some of the issues that we have, is new technology can make things happen so fast that there is no way to obviously plan for it or to recover from it. And I think that's what happened. But again, I don't think that there is no banking crisis in my mind right now. I think some of these things that are going on with PAC West and some of the other banks that are suffering greatly as far as their share price, I think I actually heard somebody say this recently, short sellers are kind of weaponizing banks, weapons of mass destruction. They're doing that so that the Fed will actually change course and bring rates back down. Who knows? I don't think there's any systemic issues with the bank, obviously, or with the banking industry. Obviously, there are the issues with the held to maturity portfolio, but there are things that are out there.
Obviously, the term funding program where you can borrow 100% of your security is at par. 100% of your security is a par, I should say. I think as of right now, there's been about $34 billion. I'm actually surprised that hasn't been used more. I don't actually know what the rates are on that money compared to what most banks are doing with the Federal Home Loan Bank. Most of the banks that I work with are in a borrowed position with the Federal Home Loan Bank trying to keep that loan-to-value down to ... loan-to-deposit ratio, I should say, down to a reasonable level. Nobody wants to get too far out there at this point.
Alex Habet
So you wrote a couple of posts. One of the reasons I wanted you to come on the show here and to walk us through those, and I would characterize those as a two-part, right?
Andy Heusel
Mm-hmm.
Alex Habet
... set. I don't know if that was your intention when you ...
Andy Heusel
No, they just kind of came together like that. So it was kind of interesting. I wrote the first one. I had been writing the first one prior to anything going bump with Silicon Valley Bank. So I felt like I needed to follow it up, really wasn't sure where I was going to go, but I kind of like the analogy of the windshield. We talk about that sometimes with how we view the world in our PrecisionLender platform, too.
Alex Habet
Yeah, so you opened that first post introducing the notion of sleepy money, which you've already mentioned here on the show. Sleepy money is the money that was stubborn to move under one environment, is no longer stubborn to move today, as you're alluding to. That all has changed. It was the middle of last year that we started to see those meaningful movements in deposit rates, and now of course it's really fast. So there's the fast follow.
In terms of the bank's investment portfolios, they were holding the large excesses of the excess deposits they were generated, of course, again, you alluded to it, some of the policies to ease the impact of COVID. But I guess the ... what's that analogy that once the tide goes out, you can see who's swimming naked or something like that?
Andy Heusel
I don't know about that one. I know about the rising tide lifting all ships, though.
Alex Habet
Well, there's the one where the tide goes down. You can see who's skinny dipping.
Andy Heusel
Yeah, that's true.
Alex Habet
I'll get the official one. So now we're finding that some banks were skinny dipping a little bit with how they manage that, which again, it's banking fundamentals, but it's not impropriety. It's probably just more of a mismanagement issue versus a systemic issue, as we've belabored on over and over again. In the post, you're running two examples to illustrate some math differences, which you've always been wonderful at doing this, right? Just to illustrate through some simple, what-if scenarios. You were modeling a transaction as if it were done a year ago with that environment and those rates, versus today. Would you mind just walking quickly where the biggest impacts were in those? Again, same transactions, just two different time periods. How different was the outcome on each?
Andy Heusel
Yeah, I think, and I don't have the numbers in front of me, and I hopefully we can show the graph, but basically the way we think of deposits, and of course we think of money market accounts, DDAs, obviously CDs, we price them differently, but we use what's called a funds transfer pricing methodology. And on those nonmaturity deposits like money markets and DDAs, we typically think of money markets as being shorter term. So kind of an 18-month point on the curve, and DDAs maybe being about 60 months on the curve. And when I say on the curve, that's your funding curve, whether it be the treasury curve, FHLV curve, whatever you're using. But obviously, when a year ago the absolute value of those curves was very low. So you might have a 50 basis point margin or less on a deposit, whereby, now even if you price up the deposit and pay a couple hundred basis points, your margin's going to be 200 basis points.
So almost on par with the loan, as far as the profitability, when you think about it. Obviously, FTP is a theoretical approach to value those, but when you think about how a bank works, the treasury sits in the middle, there's a branch that gathers deposits, there's a commercial banker that loans them out. The commercial banker's got to have that inventory and you've got to pay for it. So that's kind of how it works. So that you know, can see so that the branch that's just paying for the deposit actually can look like they're profitable. That's kind of how profitability or an internal profitability method that a bank works. So, yes, deposits have become as valuable, if not more than, loans in some cases from an internal profitability standpoint. I also think it's important to really drive that home is to manage your bank that way and incent bankers that way.
I remember a time in my career when I was actually on the line as a banker and managing a group of bankers, we actually would potentially make more money on incentives bringing in deposits versus loans. And so as things change, they always do. I think, like I mentioned in the blog, it seems like banks are always singly focused on one side of the balance sheet. Obviously now it's deposits, but usually it's growing the loan book. You've got to try your best to keep your eyes on both sides of the balance sheet and incent bankers, make changes to your incentive plans as the desire. The strategy of the bank changes, but never just focus on one side.
So we talk about incentive plans a lot with our clients. We have some consultancy that we can offer on how to create an incentive plan and then how to actually monitor it and put the numbers behind it, too. So I think that's key to keeping your bank where you want it to be from a balance sheet standpoint, all the way down to how you manage your people and how you incent them.
Alex Habet
So the first post, more quantitative, used to illustrate just the potential magnitude of what's at stake here. In the second post you transition ... you're kind of talking about it already, about rising above, just focusing on either side of the balance sheet. That's just not how this should be working. You should always look at the top and then balance both views pretty regularly, more so, I mean, I'm judging by your tone, it has to be a little bit more proactive than it has been in the past, right?
Andy Heusel
Mm-hmm.
Alex Habet
So you're bringing the qualitative conclusion to your two-part series here in that second post. You know you do a wonderful job of re-litigating why we are where we are, how the Fed got into this predicament. But you also are talking about how even though it's not a systemic issue, there are many, many institutions that are looking at significant, these are your words, "Significant capital deficiencies should some of those investment portfolios need to be sold off." So it's not the likely outcome for reasons that we talked about, right? With the new Fed facility and all that. But it's interesting how you also point to that there is a focus from a marketing perspective on safety and soundness as kind of a reactionary part to this as well.
There was, again, a lot of historical flip-flopping of focus within these banks between deposits and lending. But, again, you just remind the reader so well that it's important to rise above, never lose sight of the relationship, never lose sight of both sides of the balance sheet. And not to overly toot your horn, this is something that you and the team do very well with our clients backed by the technology that we have here. And I think you've also, in that same article, have pointed that even based on data from the FDIC, our clients typically versus their peers are outperforming across some of these key metrics that you guys are looking at day in, day out. Which is again a testament to the work that you and the rest of the team do in the dialogue with our clients every day. Talk to me about the looking ahead portion, more of the windshield. What are some things that this audience could benefit to hear from?
Andy Heusel
We use that quite frequently, a lot when we look at our PrecisionLender platform, when we look at the existing portfolio, a lot of clients say, "Well, we want to see what the trailing 12 months was. We want to see what they did in the past." And we really think of the best way to look at a relationship is what is it ... If I make this loan or I reprice this deposit, what is it going to look like going forward? And so I use that analogy a lot that there's a reason why the windshield's bigger than the rearview mirror. Obviously, you need to be able to see where you're going a lot more than ... In a much bigger format than you need to see where you've been. So that's really where that came from. Obviously, some of the new features in our platform such as the deposit price, repricing, we've always been able to have a loan renewal and what happens, what is the ROE? What does the profitability of this relationship look like? If I repriced this loan, renew this loan? But never really had a great way to do deposits. We do now. It was very timely that we were able to build that in.
So banks that are sitting on a lot of cash at a low rate, a lot of deposits at a low rate, are having to face that reality that they're going to have to pay up to keep it. And so knowing exactly how high you can go based on the value, that FTP value that I talked about earlier, that you assigned to those deposits is really key. So while you're having to price these up, your relationship profitability is likely going to go down. We know how much it costs to bring in a new client if you lose one. So paying up some of the deposits is a small price to pay.
And I think the other interesting point is, in that blog I mentioned a bank client that was complaining that their bank wasn't paying up enough for deposits. And so always be aware of the guy who's willing to pay more than market for something that you know you can get somewhere else down the street. I mean, if your bank is paying the highest rate, that probably means there's some issues going on and maybe you should be aware of that. So I think that's an important concept.
And then the other concept that's in there is really, I think there's the next thing that's going to happen here really in the banking industry is there's a ton of renewals coming down the pipe. We've got all this commercial real estate that's going to mature. Typically, those loans are done on a five-year term with some kind of a 20-year, 15-year amortization. We're about to hit a big bubble of these five-year maturities. And so banks are going to constantly be looking at the relationship. All these loans are going to renew at a higher rate, and so that's going to stress the debt service coverage or whatever credit metrics might be there. And some of these loans are going to have to find a new home. Banks are going to just say, "No, we're not going to renew this."
So I think it's going to go both ways. Obviously, these relationships, these bank clients that have deposits I think are going to find themselves, they're going to be in a much better position to negotiate that renewal at a preferential rate. And if the bank doesn't want to, obviously, if they have a lot of deposits, I think the bank would ... They don't want to lose the deposits. They might be willing to let the loan go, but if the loan and deposits go hand in hand, I think the advantage is going to be to the borrower if they contribute to a balanced relationship there.
Alex Habet
Obviously plain, simple negotiation leverage, I guess, at its finest. Yeah, sorry, go on.
Andy Heusel
Absolutely. No, again, I think that's going to be the next big topic that we deal with are some of these renewals. Obviously, we all know about the potential issues in some of the commercial real estate sectors like retail and obviously office. As you and I work from home, we no longer work in an office, so that's become pretty normal. But I will say, I think banks aren't going to see huge credit losses. I mean, bank earnings are still very strong. Most banks can earn through a normal credit loss without having to really raise additional capital or go into their capital reserves to cover that. So we'll see.
Again, there's just a lot going on with bank stocks right now. I talked about that a little bit. I think there's some short sellers that are trying to send a message to the Fed, but overall I just don't see a crisis. So anyway, I said a lot there, hopefully stayed mostly on point.
Alex Habet
So Andy, we just had a rate hike last week, so I'm curious because there was a lot of new signals that we got on this one where for the most part, I think most of the governors are more or less signaling that this could be it, although there are a few holdouts. The tricky thing is as many experts, that I'm sure you're also following as well, is the data though has been a little bit more optimistic on the inflation front, still doesn't signal where we need to be, right?
Andy Heusel
Right.
Alex Habet
So it's hard to definitively make a case or a prediction for that matter that this is it. But I'm curious what your thoughts are and, more importantly, what you think is going to happen after, let's say, a cooling-off period. Let's say there is a pause now, what comes after that pause in Andy Heusel's mind?
Andy Heusel
Yeah, so I had actually kind of thought the Fed might pause this time and not go another 25 basis points. I think these little 25 basis point hikes don't really ... There's not enough there to kind of matter in my mind. I think we've got to give some things some time to normalize. We've seen, amazingly, we've seen the volume of loans priced in our platform at an all-time high. And that's even adjusting for all the client growth that we've had or the new clients that we've brought on. So bank lending has not slowed down. Now some of that could be renewals, but it's still a ton of volume coming through the system. I checked the number myself at the end of April and it was at an all-time high again. So, nothing that I see has slowed down yet.
I mean, borrowers that are used to having a 4% long-term, five-year term rate, now they're looking at 7% or 8%. Is that going to slow things down? Everybody thinks it will, but we haven't seen it yet. So I don't have a crystal ball, but I think we will ... hopefully we'll take a pause and let some things normalize and see where inflation goes. I mean, again, it hasn't slowed down at all. I can't even hardly walk in a grocery store without getting angry anymore. I try to avoid that. So there's a lot of things going on right now in the market. So yeah, as far as the market and the banking industry, I think we're going to kind of stabilize here for a while and let it sort itself out. You know you can't really force the numbers too much. It's just going to be what it is.
Alex Habet
Alright, so a wait and see attitude from Andy Heusel, which I think is about as good of a prediction that anyone can do.
Andy Heusel
Yeah, I'm not willing to bet one way or the other. I do think, again, if you look at bank stocks, I think they're beat up a little more than they probably should be. So hopefully they'll some rational [inaudible 00:29:11]
Alex Habet
You know you mentioned it earlier in the episode, and I didn't call attention to it, that the short sellers are holding some vulnerable banks hostage in order to force the Fed's hand to stop with the rate hikes, which by the way, I think that's a headline right there, if that's true. It's an interesting perspective and it's the first time I've heard anyone frame the context in that way. But I'd be certainly curious to go do a little bit of research on that notion later on because if that is, in fact, what's going, is that something you actually read somewhere, or is that ...
Andy Heusel
No, I actually heard it on a podcast. A person that I know fairly well had a guest on and they talked about that. So I thought I would share that. I thought it was an interesting concept too. I mean, obviously there's other things like should they stop short selling of banks to try to combat some of this? Or disallow short selling? I should say that's what they did for a period in the 2008 crisis. Also, what should the FDIC do about deposit insurance? Should they increase it again? Should clients pay for deposit insurance? Obviously, there is a cost to it, clients are going to pay for it one way or the other because the banks are going to pass that on, however they're assessed. But I think there's an argument to be made that if you want to hold that kind of cash, are you willing to buy insurance? I've had clients in the past that they didn't even want GSAs as far as securities for their deposits. They wanted only treasuries. So there's some potential opportunity for a deposit product, I think, out there to address some of these uninsured deposits and start to stabilize the system.
Alex Habet
Alright. Well, Andy, I think I've picked your brain enough for this show. I want to thank you on behalf of the audience for coming on here and sharing your color commentary on top of the great content that you've published recently. And I know I speak for everyone when I say we look forward to more stuff to come for from your thought leadership.
Andy Heusel
Yeah, maybe I can get a nickname if I come on the show again?
Alex Habet
What ... the Deal Doctor does need some company, so we've got to cook something up for you, but ...
Andy Heusel
We'll have to think about that.
Alex Habet
Well, thanks again and hope to see you back here sometime soon. Before I let you go, anything you want to plug or ...
Andy Heusel
Obviously, yeah, check us out. PrecisionLender.com. We have a webinar coming up to talk about, kind of again, focus on deposits, but how some of the best banks retain deposits and some of the banks that are paying the highest rate are also losing deposits, too. So it's not all about rate, it's about the banker, it's about the relationship, and it's about the freedom that you give your bankers to negotiate. And that's where PrecisionLender becomes so important. So look forward to that. We'll have that coming up, I think in June.
Alex Habet
Excellent. Look forward to it. Andy, thank you again, and hope to see you again here on The Purposeful Banker sometime soon.
Andy Heusel
Thank you.
Alex Habet
That's it for this week's episode of The Purposeful Banker. If you want to catch more episodes, please subscribe to the show, wherever you like to listen to podcasts, including Apple, Spotify, Stitcher, and iHeartRadio. And if you have a minute to spare, let us know what you think in the comments. You can also head over to q2.com to learn more about the company behind the content. Until next time, this is Alex Habet and you've been listening to The Purposeful Banker.
