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Where Is Your Deposit Growth Coming From?

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Many financial institutions have become increasingly concerned about liquidity and for good reason. While deposit growth is often celebrated, where that growth is coming from can have important implications with respect to liquidity, A/LM, and future plans around membership and asset growth. Is your institution’s deposit growth coming primarily from growth in new accounts or growth in average balances?

For some credit unions, the change in average deposit balance can represent a substantial risk to maintaining sufficient liquidity. The example data displayed below shows a credit union that over the last 10 years increased average share balances by 51%, share drafts by 76%, and money markets by a whopping 139%.

Where Is Your Deposit Growth Coming From

 

If you look at the lower portion of the matrix above, note that 73% of growth in shares was from increasing average balances, 27% of the growth was from new accounts. Money markets and share drafts were even more lopsided toward average balance growth. The vast majority of this institution’s deposit growth has come from increasing average balances, as opposed to adding new accounts.

Is this growth because relationships are deeper or is it that members are sitting on more money when the rate alternatives are so low? What could this mean for liquidity exposure, if rates go up or the market gets excited about keeping money somewhere else? Consider that share accounts could be materially more sensitive to moving money than they were in the past. Combine this information with the knowledge that in the last rising rate environment smartphones did not exist—liquidity risk has increased, as it is now easier than ever to move money.

Another way to look at this could be to consider what the deposit growth matrix would look like if the growth were pegged to inflation (conservatively assuming a 2% inflation rate over the last 10 years). If average balances grew at a 2% annualized rate, the credit union would have accumulated 18% less in regular shares, 30% less in share drafts, and 48% less in money markets. This would represent almost $522M fewer deposit dollars over the same 10-year period.

Where Is Your Deposit Growth Coming From

 

Additionally, if a credit union has become more active in indirect lending, it is important to understand how indirect members are impacting average deposit balances (since indirect members often carry small or minimum share balances). If indirect account holders are excluded, the average share balance utilizing the same example credit union would have increased by 63% over the same period of time (compared to 51% including indirect members), and increases in average balances would account for 94% of the growth in shares as opposed to 73%. For some credit unions, the impact of indirect members could be more significant.

From a policy perspective, having this type of data readily available can help to inform contingency funding plans and how you stress your liquidity simulations. Some credit unions evaluate their bad case liquidity scenario by analyzing growth in average balances over time and assuming that a portion of that “excess” growth leaves the credit union. This can help put some historical context around your liquidity stress testing.

Financial institutions are potentially entering unprecedented territory with respect to the pattern of interest rates, and how members will behave is unknown. As you plan for liquidity, consider evaluating how your average deposit relationships have changed, what it could mean for your institution, and what you could do now to prepare.

C. myers has posted several entries on our blog over the last year about this important topic. Click here to see more.

Selling Investments for Liquidity

A few weeks ago, we discussed increasing loan-to-share ratios resulting from loan growth outpacing share growth.  The blog went on to discuss the potential liquidity pressures some could experience, today or in the future, if this trend continues.

To keep the lending machine going, many decision-makers maintain that to fund future loan growth they will sell investments in the future.  While this may be an option worth considering, market rates in the future are uncertain and it can take a considerable amount of time to offset losses you may take on the sale of investments.  Let’s walk through an example:

Assume a credit union is experiencing continued loan growth and it also holds a $100M agency bullet, with three years remaining until maturity, earning 0.75%.  Their liquidity analysis is projecting they may need to sell this investment in 12 months to help fund loan opportunities.

Rates could go in any direction but what if rates increase 1% in the next 12 months?  The credit union sells the $100M investment, now with two years remaining until maturity, at a $1.6M loss.  If rates increase 3% in the next 12 months, the loss is $5.4M.

Sell Asset in 12 Months

Beyond asking if the credit union is willing to take the loss, the next question should be, How long it will take new lending opportunities to offset the loss? Assuming loans will yield more as rates go up, it could take up to six months to recoup the loss on the sale in a +100 basis point (bp) increase in rates and 17 months in a +300 bp increase in rates.

Months to Breakeven

The objective here is not to advocate a particular strategy, rather to encourage thorough analysis and provide a different perspective for credit union boards and managements to understand the trade-offs of difficult decisions.

Liquidity Risk: Loan-to-Share Ratios Are Moving Up

Throughout the sustained, low interest rate environment, many credit unions have become flush with non-maturity deposit funds, while also experiencing lackluster loan growth.  In other words, liquidity risk hasn’t necessarily been at top of mind.

However, as the economic landscape shifts and murmurings of an increase in government interest rates grow, the issue of liquidity may become an increasing concern once again.  According to June 2014 NCUA Aggregate data, loan growth (on average) continues to outpace share growth.  What if this trend continues and/or accelerates?

NCUA Aggregate Data Table

One thing to consider is analyzing how your members’ average balances have evolved since the last economic rate cycle back in the summer of 2007 when short-term rates were at 5%.  Key areas to address include:

  • What would my liquidity position look like if members reverted back to historical average balances?
  • What options do I have available, and what are the financial implications of those options, if the above scenario caused a stressed liquidity position?
  • As discussed in earlier blogs, the mix and cost of your deposits will also change as rates rise.  See our post on Isolating Interest Rate Risk with a Static Balance Sheet for more detail on this

While it may not feel like a problem today, highly successful credit unions are continuously looking forward and staying ahead of the curve.  Take the time to understand your liquidity position today and the threats and opportunities of tomorrow so that when the future is realized, you’ll be better prepared.