Regulators will be looking closely at how you respond to the large cash influx driven by federal stimulus payments.
This blog was originally published on Plansmith’s blog.
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It seems like just yesterday (okay, it was a year ago) that I had just written a blog declaring the death of surge deposits—significant and abnormal deposit growth with uncertain long-term stability that financial institutions experience for any number of reasons.
In my earlier post, I noted how at the time of, and following the 2007-2009 Great Recession, the banking industry saw a substantial influx of deposits, as real estate and equity investors liquidated positions and sought safe places to store their money and ride out the storm. I further noted that, as rates for certificates of deposit plummeted during and following the economic crisis, CD holders weren’t being provided with any incentive to have their money “locked” into time deposits. As time deposits matured, CD holders routinely moved their balances into more liquid non-maturity deposits. These former CD holders were essentially temporarily “parking” their money in NMD accounts, just waiting for CD rates to return to what they believed were more “normal” levels, at which time they’d move the balances back into time deposits.
Given the potential liquidity and interest rate risk associated with those surge deposits, regulators expected banks and credit unions to review their deposit composition, identify potential surge deposits and consider the risk(s) associated with such deposits. In my 2020 article, however, I highlighted that in late 2018 and into 2019, we saw a market-wide spike in CD rates, and it was not uncommon to see one-year CD rates of near 2.75% and five-year rates of 3.25% or more. At the same time, most financial institutions left NMD rates at or near their historic low levels, which should have been more than enough incentive for surge depositors to move their “parked” funds back into CD products. The whole point of the article was to highlight that any former “surge” balances still left in NMD accounts in 2020 should no longer have been considered “surge” or be viewed as having increased volatility characteristics, thus ending the “surge deposit” era.
While I still stand by that argument, it turns out that what’s old is new again, and we’re back to a new era of surge deposits; let’s call it Surge 2.0. Surge 2.0 is what happens when the federal government injects roughly $6 trillion of cash into the U.S. economy. And no matter how you feel about the various pandemic-related stimulus packages, the fact is that the bulk of that cash has found its way into banks and credit unions everywhere.
We’ve seen deposits at most of our clients’ institutions grow at least 10-20% in 2020. That’s actually more than a “surge.” It’s a tidal wave, and just like that first era of surge deposits that followed the Great Recession, these surge deposits can be a great low-cost funding source. But, also like those post-recession surge deposits, you can bet that regulators will be looking closely to see what you’ve done to assess their stability and, more specifically, what adjustments you’ve made to the decay rates you’re using in your interest rate risk model.
What Regulators Are Looking For
In setting decay rate assumptions, regulators expect credit unions to consider making qualitive adjustments that reflect current-period market conditions and anticipated customer behavior in response to interest rate fluctuations, such as the assumed runoff of surge deposits. You may even be asked to expand your cash flow modeling efforts to include a stress scenario to show the potential run-off of these newfound deposits.
If you haven’t yet reviewed your deposit base and quantified the level of potential Surge 2.0 deposits, it is highly recommended that you do so as soon as possible. You can do the legwork yourself or hire a third party professional advisory team like Plansmith, but whatever the case, ensure it’s done properly.
When you complete your analysis, you’ll need to generate documentation to show examiners (we suggest a 20-year deposit trend analysis) and use the results to adjust your decay assumptions and cash flow modeling scenarios.
While I once—not so long ago—said surge deposits were as dead as a sweater from the ’80s, they’re back. Make sure your credit union is prepared for Surge 2.0 and not only has well-supported institution-specific decay data, but also has made the qualitative adjustments necessary to account for the trends you’re seeing in your deposit base.
Director of ALM advisory services at CUES Supplier member Plansmith, Dave Wicklund is a former senior bank examiner and capital markets expert for the FDIC. He is also a director and ALCO chairman for a bank group that employs a complex liquidity management system and uses material levels of non-traditional funding sources.