What a difference a year makes. When we started 2022, deposits were rather boring and played second chair to the asset side of the balance sheet. For many years, we referred to deposits as being “sleepy money,” meaning that due to the low-rate environment, there wasn’t a lot of pursuit of higher yields, and many financial institutions were content to let their deposit accounts stay where they were and earn a very low return. All of that has changed in the past several months, as seen in the below chart first published in our 2023 State of Commercial Banking report.
Banks are starting to grapple with severe liquidity issues caused by several factors, including inflation that is draining the savings of many institutions. Meanwhile, the rate hikes the Fed is using to combat inflation are leaving much of the bank investment portfolio that absorbed the excess pandemic deposits sitting at a loss, with treasurers reluctant to realize those losses in their held to maturity (HTM) portfolio. Finally, banks are starting to increase deposit rates following the Fed moves, so this funding source is no longer “sleepy.”
To show the actual value change over time, let’s consider an opportunity that was priced in early 2022. For this example, we will consider a $2 million term loan for 60 months with a 180-month amortization priced at 266 bps over the five-year Treasury and a $500,000 non-interest DDA account. Our DDA account is valued based on the 60-month point on the FHLB curve, while the loan uses the current FHLB curve at the time of origination. As is evident in the chart below, all else equal, the new loan and deposit opportunity ROE grew by 22%, and the NIM on the deposit opportunity grew by 137%.
To further illustrate the premium that deposits are demanding on the balance sheet, consider a $2 million Money Market account, which is typically valued at the 18-month point on the funding curve. The rate paid is indexed to the five-year Treasury, which was 1.26% and 3.48% for January 2022 and February 2023, respectively. Indexed to the five-year Treasury in early 2022, the margin was actually negative due to an FTP credit of only 86 bps. Currently, the margin is very attractive due to a 4.76% yield based on FTP application due to a downward sloping yield curve on the longer end.
Using Q2 PrecisionLender to Refine Your Deposit Pricing Strategy
So how should financial institutions value these deposits? Q2 PrecisionLender offers some options.
1. Apply FTP Value to Deposits
Q2 PrecisionLender has two ways to apply FTP value to deposits. (Learn more about setting up deposits.) One is by using “point on curve,” which will apply FTP credit based on the underlying funding curve at the point chosen. Historically, our recommendations for non-maturity deposits (MMAs and DDAs) have been about 18 months for Money Market and Now and 60 months for DDAs. This translates into the assumption that DDAs are less volatile as they represent operating accounts that are not as likely to move and are “more sticky.” Therefore, they are assumed to have a longer duration and, in a normal upward sloping curve, a higher FTP value.
This is not the case in the current environment. Currently, a Money Market Account can be priced up to 1.09% to get a comparable return and margin to a DDA that is paying 0%. This does give the bank some price flexibility in the current competitive environment, with excess deposits now expecting to generate a much higher return for depositors.
2. Use a Funding Curve Override
Other than setting specific deposit FTP rates, Q2 PrecisionLender offers the capability to use a “Funding Curve Override” at the product level, which allows an administrator to decide to use a different funding curve for all deposits or even a separate curve for each deposit product. Currently, many banks that are borrowing from other sources such as the FHLB are borrowing at shorter points; therefore, their actual marginal funding cost may be mismatched if the term of the loan is further out in duration. The same can be said for deposits, whereby longer-term DDAs are being undervalued with the mismatch. An administrator could decide to shorten the “point on curve” to closer align with the term of the bank's actual marginal funding exposure. For help enabling this functionality, please contact our Support team.
3. Offer Teaser Rates
Many banks are offering “teaser” rates on Money Market Accounts, whereby a higher rate is guaranteed for some period. These rates are generally much higher than average to attract additional deposits. One strategy is to set up a specific deposit product to track that pipeline and production and also tie the value to the point on a Treasury curve that matches the guaranteed period so that, as the Treasury curve moves, so does the value of those deposits.
4. Evaluate Pricing
A recent development for Q2 PrecisionLender is the addition of Deposit Repricing. With this addition, your bankers now have the ability to replace, remove, or reprice existing deposits and understand the "if we win" and "if we lose" scenarios. Now more than ever, our clients are asking about deposit rates, and this new feature will make it very easy to see what the impact of a deposit reprice will have on the relationship.
Our Andi developers are busy making Andi the most useful pricing analyst in the business. Be on the lookout for new Andi skills that will easily allow an administrator to 1) alert users when their pricing exceeds any policy limits or 2) show a banker what the rate tiers should be based on balance. Email firstname.lastname@example.org to be alerted to these and other Andi updates.
At this point in the rate cycle, there is no more powerful tool than Q2 PrecisionLender to drive balance sheet strategy, specifically deposit-gathering activities. Q2 PrecisionLender is the world’s most advanced sales and negotiation tool, with a majority of our recent innovations centered on enhancing capabilities in Deposit and Treasury Services pricing capabilities to help bankers strengthen relationships and portfolios across the full breadth of the commercial bank. Q2's Customer Success organization, including our Advisory Team, is here and ready to discuss options to optimize the platform to meet your strategy and goals.
Get More Insights at Our Upcoming Webinar
Join Q2 PrecisionLender experts on June 7 from 2 to 3 p.m. ET as they review three bank profiles created from proprietary Q2 PrecisionLender data to highlight what’s going right and what could go wrong in the race for liquidity.