Pub. 3 2015 Issue 3

Issue 3. 2015 13 Brett Manning 206.340.2472 bmanning@fhlbdm.com Eric Jensen 206.340.2489 ejensen@fhlbdm.com It’s more than a house. IT’S A HOME. It’s more than a loan. IT’S A DREAM COME TRUE. It’s more than a customer. IT’S A COMMUNITY. We’re more than a bank. WE’RE A PARTNER THROUGH IT ALL. FIND THE SOLUTIONS. DoMore .fhlbdm.com Nowhere are these circumstances more relevant and the related assumptions more apt to be questioned than in the modelled por- trayal of those assumptions governing the behavior of non-ma- turing deposits (NMDs). So, despite the oftentimes-exhaustive efforts to produce assumptions that will help management antic- ipate the behavior of the owners of those deposits, such efforts still leave many questions unanswered. The three most relevant questions that seem to be on the minds of many relate to price sensitivity, balance stability, and the impact of disintermediation. Will the historically low beta price sensitivity of NMDs continue into a higher-rate environment, or will yield-starved customers demand a greater degree of mar- ket sensitivity? Will the long average lives characterized by the unflaggingly core-like nature of NMDs play out as expected, or will these accounts become more volatile with higher decay rates? And lastly, will these surging deposits even stay in the bank or will they have to be replaced by more costly funding alternatives? Be Your Own Bearer of Bad News Questions about inputs unfailingly lead to questions about outputs and have become the source of much regulatory conster- nation. Regulators are concerned that model-generated reports, driven by overly optimistic assumptions, are leaving community bankers with a false sense of security as they evaluate their risk preparedness. To address this concern, risk managers are encour- aged to conduct sensitivity testing of their assumptions. By isolat- ing a particular assumption and stressing its value to the bank’s detriment, management should have a better understanding of the risks associated with over-hopeful assumptions. While regulatory pronouncements have left the degree of stress unspecified, pricing betas for NMDs should be appreciably ratcheted up if management truly wants to see what levels of interest expense might await them. The rock-solid and long-lived nature of those NMDs should also be put to the test with higher decay rates and shorter average lives than what historical analysis might suggest. Your perceived insulation from Economic Value Equity (EVE) depreciation might prove to be a false perception. And finally, simulating the effects of having to replace the loss of a significant percentage of core deposits with brokered funds or borrowings has negative implications for earnings-at-risk and EVE volatility. The results of these input changes may paint a picture of risk exposure far less sanguine than what is currently perceived, but that’s the point. By stressing these key assumptions, risk manag- ers are forced to evaluate the results of an environment they are loathe to accept, but which may more accurately reflect future conditions. And while this news may be no more welcome than finding out that the cow has eaten the cabbage, it’s preferable to being blindsided by faulty assumptions. n Lester F. Murray, Associate Partner of The Baker Group LP, came to the Baker Group in 1986 following his work with the OCC as an assistant National Bank Examiner. His focus is on developing community bank portfolio and inter- est rate risk management strategies. Contact: 800-937-2257, lester@GoBaker.com .