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Net Economic Value: What is a Reasonable Value for Non-Maturity Deposits?

When approaching net economic value (NEV) analyses, the issue of valuing non-maturity deposits has been a point of contention for practitioners and regulators alike.  The focus traditionally is on the question:  What is the final maturity of a deposit that contractually never matures?  In the end, the nature of the question of maturities needs to change.  Determining cash flows is simply a means to the end of valuation.  While it could be very defendable that the final maturity of a regular share account is in excess of 10 years, would the market really pay the resulting premium?

If the objective is to understand economic value, the true focus of the question should be:  What is a reasonable value for my non-maturity deposits?
Rather than relying on maturity studies to dictate the results, consider the following:
  • What kind of premium would you pay for non-maturity deposits today?  (Keep in mind many institutions are still trying to figure out what to do with excess funds.)
  • What kind of premiums have been paid on non-maturity deposits in today’s low-rate environment in actual mergers?
  • What about premiums on non-maturity deposits when rates were at their last peak back in the summer of 2007?
Based on this kind of empirical evidence, the above considerations could serve as a better proxy for value than maturity assumptions.  Furthermore, stress testing could be done by shocking historical premiums, asking the question:  What if the market doesn’t pay as much of a premium going forward?
If you utilize NEV analysis as part of your asset/liability management (A/LM) process, do a “gut check” on the resulting value of your non-maturity deposits.  If you wouldn’t pay the resulting premium, chances are most others in the market wouldn’t either.  Regardless of what an academically sophisticated analysis dictates a final maturity to be, decision makers must rise above the methodology and traditional focus of assumptions and ask themselves if the resulting value makes sense.
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Examiner FAQs

We frequently hear about examiner inquiries regarding non-maturity deposit assumptions in credit union A/LM models.  The question is usually along the lines of, “what are the non-maturity deposit assumptions used in the A/LM modeling and how were they determined?”

Non-maturity deposit assumptions include pricing sensitivity and withdrawal sensitivity.  When it comes to pricing sensitivity the modeling needs to have assumptions about what the credit union thinks it will pay on its non-maturity deposits in different rate environments.  While there are many things to consider when it comes to pricing, one approach is to look at how the credit union has priced deposits in the recent past.  Short-term rates, which influence deposit pricing, were around 1% in 2003-2004 then rose steadily to about 5% in the 2006-2007 timeframe before dropping to the historically-low rate environment of the last few years.  A good starting point is to base your pricing assumptions on how you actually priced during this rate cycle.

Withdrawal sensitivity models the behavior of members who move their funds from lower-paying deposits (like regular shares) to higher-paying ones (like CDs) when presented with an opportunity to do so.  This behavior is much more difficult to observe than how deposits were priced in different rate environments.  In fact, in the IRR Questionnaire, NCUA says, “The uncertain timing of NMS account cash inflows and outflows can make treatment challenging.  It is not possible to predict with certainty what future balances in non-maturity accounts will be, how long they will remain open, or what future rates will be paid to members on these accounts.  Even when CUs study member behavior, or contract with vendors to perform such a study, substantial uncertainty remains.”

Similar to the approach with pricing, it is possible, however, to observe how your credit union’s deposit balances responded during the last rate cycle.  Reviewing balance changes, especially during the period of 2004-2006 (when short-term rates were increasing), can provide a basis for withdrawal sensitivity assumptions.  Still, there is nothing in recent history that replicates this extremely low-rate environment and there are valid concerns that member behavior in the future may be very different than in the past. Movement of funds to higher-paying deposits, or having to replace funds that are leaving with higher-paying deposits, can dramatically increase a credit union’s cost of funds.  As with the pricing assumptions, it is a good practice to stress test these assumptions by asking, “what if our member withdrawal is X% (for example 50%) greater than assumed?”

One last consideration:  the type of analysis you are doing. Deposit pricing assumptions are needed for static and dynamic balance sheet income simulations, NEV and long-term risk to earnings and net worth simulations.  Withdrawal assumptions are needed for NEV and long-term risk to earnings and net worth simulations.  While dynamic simulations wouldn’t necessarily employ withdrawal assumptions, it is possible to model changes in the deposit mix. Static balance sheet income simulations, by definition, ignore this threat by assuming that deposits never leave and that members never act in their best interest by moving to higher-paying deposits.

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NEV Shares At Par

Q: Does assuming NEV non-maturity deposits at par isolate changes in balance sheet structure?

A: No.

Some people think that valuing non-maturity deposits at par is more conservative and isolates changes in balance sheet structure simulation to simulation.  This is not the case.  NEV with non-maturity deposits at par shows exactly the same result whether 10% or 50% of the credit union’s structure is in money markets.  It also shows the same result regardless of whether these rates are 10 basis points or 210 basis points.  How can this type of analysis isolate changes in balance sheet structure when it ignores the deposit mix and deposit pricing?  Ignoring sources of risk cannot be considered conservative.