ALCO Process - Funds Management


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Rather than shy away from some of the more efficient non-core funding techniques, we believe it wise to make certain your Board and your Examiners understand what is being accomplished through the use of wholesale funding tactics and our third webinar on the ALCO Process is designed to describe an approach to this issue. We will provide guidance on:

1. Where to describe your strategy.
2. Limits to place on non-core funding.
3. Reporting the use of non-core funding.
4. Non-core funding products and services that are in use today.
5. Pros and Cons of these funding sources.

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ALCO Process - Funds Management

  1. 1. KPN Consulting Webinar Series Part 3 of 6 Funds Management
  2. 2. Core Vs. Non Core <ul><li>Though Core Is Normally Less Expensive, We Do Encounter Moments When Non Core Is Cheaper … This is increasing the case when discussing large CD clients. </li></ul><ul><li>We Have Been Experiencing That “Moment” For About 18 Months … </li></ul><ul><li>Let’s Look At Today’s Environment … </li></ul>
  3. 3. Core Vs. Non Core <ul><li>One Year CD Rate To Raise $250,000? </li></ul><ul><ul><li>Brokered Rate: </li></ul></ul><ul><ul><li>FHLB Rate: </li></ul></ul><ul><ul><li>CDARS Rate: </li></ul></ul>
  4. 4. Core Vs. Non Core <ul><li>Does Anyone See a Dilemma? </li></ul><ul><li>Should We Raise Funds Most Efficiently (Shareholders Issue) or To Please Regulators? </li></ul><ul><li>Of course, your answer may be impacted by your present situation (Consent Order!). </li></ul>
  5. 5. Banks Should Not Use Volatile Sources to Fund Aggressive Growth <ul><li>FDIC Financial Institution Letter 3-3-09 </li></ul><ul><li>1 and 2-rated banks will be monitored for growth </li></ul><ul><li>3,4, and 5-rated banks should have plans to stabilize or reduce risk exposure and limit growth </li></ul><ul><li>Plans should not include use of volatile funds or temporarily expanded FDIC insurance or liability guarantees to fund growth or risky activities </li></ul><ul><li>Continuing prudent lending practices not generally considered a risky practice </li></ul>
  6. 6. Funds Management <ul><li>Regulators Have Become More Positive About Other-Than Core Funding During the Past Ten Years. </li></ul><ul><li>That Said, Regulators Are Clearly Alarmed By The Abuse of Non-Core Funding And Its Role In The Present Crisis. </li></ul><ul><li>It Makes Sense For Any Institution, That Desires To Fund Outside The Core, To Make Certain It Has Policies and Procedures Describing How Wholesale or Non-Core Funding Will Be Used. </li></ul>
  7. 7. Funds Management <ul><li>There Are Many Stories Today About Examiners Discouraging The Use of Wholesale Funding and This Discussion Truly Misses The Point …. </li></ul><ul><li>Liabilities Do Not Cause Banks To Fail … But Assets Do! </li></ul><ul><li>However, There is A Connection To Failed Banks Growing Too Fast and the Use of Brokered Deposits and That is Really The Issue. </li></ul>
  8. 8. Funds Management <ul><li>So, A Good Way To Avoid That Issue Is To Either Fund Entirely From The Core (Which For Most Means Very Slow Asset Growth), or … </li></ul><ul><li>Have A Carefully Defined Non-Core Funding Strategy. </li></ul><ul><li>Let’s look At How We Make Certain We Have This Under Control …. </li></ul>
  9. 9. Funds Management <ul><li>We Should Find Our Strategy Embedded In Three Different Concepts: </li></ul>ALCO Policy Contingency Funding Plan Wholesale Funding Report
  10. 10. The ALCO Policy <ul><li>Key ALCO Components: </li></ul>Interest Rate Risk Management Profit and Spread Management Capital Management Liquidity Risk Management Funds Management Investment Risk Management
  11. 11. ALCO Policy <ul><li>Funds Management </li></ul><ul><li>The ALCO Policy Should Describe The Various Funding Sources You Will Use. </li></ul><ul><li>The Policy Should Also Indicate The Limit You Will Place on the Use of Wholesale Funding Sources – I Would Suggest Using % of Assets. </li></ul><ul><li>And, Your Policy Should Indicate Limits For Each Specific Source of Funding - % of Assets. </li></ul><ul><li>Remember That The Two Largest Sources of Wholesale Funding for Community Banks Are FHLB Advances and Brokered Deposits. </li></ul>
  12. 12. Role of Wholesale Funding 12/31/05 – 12/31/10 Bank Thrift Industry Data (in Trillions) 2005 2006 2007 2008 2009 2010 Deposits $7.141 $7.825 $8.546 $9.037 $9.227 $9.422 Mutual Funds $8.906 $10.414 $12.039 $9.601 $11.121 $11.817 Total Wholesale Funding $2.077 $2.160 $2.464 $2.673 $1.852 $1.773 Total Assets $10.877 $11.860 $13.039 $13.853 $13.134 $13.321 Wholesale Funding / Total Assets 19.1% 18.2% 19.7% 19.3% 14.1% 13.3%
  13. 13. Funding Limits <ul><li>The Limits You Set Should Be Customized To Your Institution. </li></ul><ul><li>The Limits Should Relate To The State of The Industry … Over The Past Ten Years % Has Been Around 19%. </li></ul><ul><li>The Limits Should Be Ones That You Will Likely Not Ever Achieve. </li></ul><ul><li>And These Limits Should Be Approved By Your Board and Discussed With Your Regulators. </li></ul>
  14. 14. Funding Sources <ul><li>Many New Forms of Non-Core or Wholesale Funding Have Come On Our Scene in the Past 20 years … </li></ul><ul><li>In Fact, All That These Vendors Are Doing is “Tapping” Sources That We Have Difficulty Accessing and Offering Them To The Banking System. </li></ul><ul><li>If We Could “Tap” Them, We Would! </li></ul>
  15. 15. Wholesale Funding Sources <ul><li>Funding Without Collateral: </li></ul>Fed Funds Purchased Rate Board Brokered Deposits CDARS IDC Deposits Reich & Tang
  16. 16. Wholesale Funding Sources <ul><li>Funding With Collateral: </li></ul>Repurchase Agreements FHLB Advances Federal Reserve Discount Window
  17. 17. Fed Funds Purchased <ul><li>“ Whiskey & Tickets” Model </li></ul><ul><li>Role of Bankers Banks </li></ul><ul><li>Today’s Model </li></ul>
  18. 18. Fed Funds Purchased <ul><li>The Fed Funds model is both a buy (purchased) and sell (sold) model and pricing is not consistent on either side. </li></ul><ul><li>This is a price credit sensitive market that may disappear if your institution experiences problems. </li></ul><ul><li>Consider having several Fed Funds partners so that you can properly evaluate pricing. </li></ul>
  19. 19. Internet Listed CD’s <ul><li> VS. Qwickrate </li></ul><ul><li>Some internet sites provide banks to raise CD’s without the use of “Brokered” label…Public sites that provide information only… </li></ul><ul><li>Others – Qwickrate and CD Rateline are private sites that provide a more interactive experience and are not considered “Brokered”… </li></ul>
  20. 20. QwickRate eContact Activity by Month
  21. 21. Nationwide Unbiased Rate Information
  22. 22. QwickRate Activity By Term
  23. 23. QwickRate Activity by Position
  24. 24. Deposit Classification <ul><li>The FDIC classifies a rate board as a “non-brokered deposit listing services” if the rate board meets the following criteria: </li></ul><ul><ul><ul><li>Charge subscription fees only </li></ul></ul></ul><ul><ul><ul><li>Fees not charged on number or dollar value of CDs placed </li></ul></ul></ul><ul><ul><ul><li>Performs no services except gathering and transmission of information </li></ul></ul></ul><ul><ul><ul><li>The listing service is not involved in placing deposit </li></ul></ul></ul><ul><li>Deposits obtained directly as a result of a bank listing rates on a rate board will be classified as non-brokered. </li></ul><ul><li>“ Time deposits less than $100,000” on schedule RC-E of the call report </li></ul><ul><li>Included in the UBPR calculation of core deposits </li></ul><ul><li>Does not effect your banks dependency on non-core funding liquidity ratios </li></ul>
  25. 25. Brokered Deposits <ul><li>Stigma Still There? </li></ul><ul><li>Growth of Marketplace </li></ul><ul><li>Why Use Them? </li></ul>
  26. 26. Brokered Deposits <ul><li>“ The FDIC, in its manual of examinations, states that the use of brokered deposits should not be discouraged, and it should not have any stigma attached to it, provided that the bank uses it in a prudent manner and as part of an overall liability management program .” </li></ul><ul><li>- American Banker </li></ul>
  27. 27. Brokered CDs on the Rise Year End Institutions Deposits 2000 1611 $196 billion 2001 1709 $233 billion 2002 1877 $253 billion 2003 2121 $331 billion 2004 2473 $428 billion 2005 2850 $482 billion 2006 3341 $540 billion 2007 3339 $586 billion 2008 3938 $829 billion 2009 3759 $629 billion 2010 3758 $497 billion
  28. 28. Brokered Deposits - Facts <ul><li>Business Began With “Pass- Through” Approval in 1985. </li></ul><ul><li>For Many Years, This Was A Business Only For Large Issuers. </li></ul><ul><li>In The 1990’s, Regional Brokers Entered the Marketplace And Business Spread To Community </li></ul>
  29. 29. Do They Require Regulatory Approval? <ul><li>Prior regulatory approval is not required if “Well Capitalized” </li></ul><ul><ul><ul><ul><li>Total Risk Based > 10% </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Tier 1 Risk Based > 6% </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Tier 1 Leverage > 5% </li></ul></ul></ul></ul><ul><li>For “Adequately Capitalized” institutions a waiver from the FDIC must be obtained prior to issuance. </li></ul><ul><li>No early withdrawal opportunity other than “death put option” </li></ul>
  30. 30. Suggested Regulatory Guidelines <ul><ul><li>Include and adhere to the guidelines in your liquidity policy. </li></ul></ul><ul><ul><li>Provide an executive summary to your Board of Directors. </li></ul></ul><ul><ul><li>Consider the effect of the wholesale borrowing on your asset/liability position. </li></ul></ul><ul><ul><li>Contingency planning </li></ul></ul><ul><ul><li>Alternatives to reduce dependency </li></ul></ul>
  31. 31. Financial Northeastern <ul><li>If You Want To Check on Rates …. </li></ul><ul><ul><li> </li></ul></ul><ul><ul><ul><li>Enter Site </li></ul></ul></ul><ul><ul><ul><li>Current CD Rates </li></ul></ul></ul><ul><li>Likely, Brokered Deposits and FHLB Advances Will Continue To Be Key Community Banking Tools. </li></ul>
  32. 32. Brokered Deposits <ul><li>Moving From The Wholesale to the Retail Arena: </li></ul><ul><ul><li>IDC Deposits – Money Market Solution </li></ul></ul><ul><ul><li>CDARS – CD/Money Market Solution </li></ul></ul><ul><ul><li>Reich & Tang – Money Market Solution </li></ul></ul>
  33. 33. EXPANDED FDIC INSURANCE COVERAGE & FLOW OF FUNDS Bottom Line for the Customer: All Funds are 100% Insured
  34. 34. Liquidity Provided By: Banks and their customers MMAX Accounts Funding the Balance Sheet Custodian: Wells Fargo Your Bank
  35. 35. Funding Solution Long Term MMA Funding – 93% of deposits retained on an annual basis Easy & Reliable – very little back office support and simple documentation No CIP/AML issues No Collateralization Use it when you need it Current rate – Call For Quote Requirement – the bank must be “well capitalized” as defined by the FDIC
  36. 36. Funding Solutions That Lead the Way… <ul><li>Promontory offers smart, profit-building services that can help financial institutions like yours to compete more effectively. </li></ul>Does your bank want to: <ul><li>Meet deposit goals? </li></ul><ul><li>Reduce collateralization costs? </li></ul><ul><li>Free up pledged securities to fund loans that earn a higher return? </li></ul><ul><li>Expand its customer base? </li></ul><ul><li>Enhance customer loyalty? </li></ul><ul><li>Lower customer acquisition and maintenance costs? </li></ul><ul><li>Present a consistent face (CD offering) in the marketplace without adding to its balance sheet? </li></ul><ul><li>Discourage customers from banking elsewhere during periods of strong liquidity? </li></ul><ul><li>Take funds off of its balance sheet without turning good customers away? </li></ul><ul><li>Earn fee income? </li></ul><ul><li>Gain pricing leverage? </li></ul><ul><li>Purchase cost-effective wholesale funding without collateralization or stock purchase? </li></ul><ul><li>Diversify its funding sources? </li></ul>
  37. 37. The Power of CDARS ® <ul><li>You can also use CDARS as a funding and liquidity management tool to access cost-effective funding, manage your balance sheet, and enhance profitability. </li></ul><ul><li>Nearly 3,000 Promontory Network members – financial institutions across the nation – do so already. </li></ul><ul><li>With CDARS, you can offer depositors access to $50,000,000 (or more) of FDIC insurance on CD investments. </li></ul>
  38. 38. Build Your Customer Base <ul><li>CDARS offers investors: </li></ul><ul><ul><li>The flexibility to select from a range of maturities. </li></ul></ul>4 Weeks 13 Weeks 26 Weeks 52 Weeks 104 Weeks (2 Years) 156 Weeks (3 Years) 260 Weeks (5 Years)
  39. 39. How Does CDARS ® Work? <ul><li>When a bank places a customer’s deposit through CDARS, that deposit is divided into amounts under the FDIC insurance maximum* and allocated among other Promontory Network member banks (making the full amount eligible for FDIC insurance). As a result, customers can access coverage from many institutions while working with just one. </li></ul>*The standard FDIC insurance coverage amount is $250,000 per insured capacity per bank through December 31, 2013. Thereafter, the standard FDIC coverage amount will revert to $100,000 unless Congress further extends the higher coverage amount. Accordingly, for CDs that mature on or before December 31, 2013, customer funds will be allocated to banks that are members of the Promontory Network in amounts up to $250,000, and for CDs that mature after December 31, 2013, customer funds will be allocated in amounts up to $100,000.
  40. 40. CDARS ® Reciprocal SM Transactions <ul><li>Deposits placed through the service are considered brokered deposits under call report instructions. However, unlike traditional brokered deposits, CDARS Reciprocal deposits are not viewed as unusually volatile. Because the reciprocal deposits you place through CDARS come from your local customers (usually within 25 miles of a branch), they tend to behave like core deposits. </li></ul>
  41. 41. CDARS = Rate Board <ul><li>CDARS Also Has One-Way Buy and Sell Available – This Allows its Members To Take Care of Depositors Without Taking Funds On To The Balance Sheet … </li></ul><ul><li>It Also Allows Members To Bid For Funding From Those Who Sell To The Network … </li></ul><ul><li>Right Now – One-Way Buy Is Extremely Attractive Funding! </li></ul>
  42. 42. <ul><li>Core Deposit Funding Solution </li></ul><ul><ul><li>Intrasweep On-Balance-Sheet Sweep </li></ul></ul><ul><li>- Attract and retain core deposits </li></ul><ul><li>- Support local loan demand </li></ul><ul><li>Near-Core Funding Solution </li></ul><ul><ul><li>Demand Deposit Marketplace </li></ul></ul><ul><li>- Expanded FDIC protection with 100% daily liquidity </li></ul><ul><li>- Acquire, send or swap (reciprocal) deposits </li></ul><ul><li>- Most flexible liquidity management tool available </li></ul><ul><li>Non-Core Funding Solution </li></ul><ul><ul><li>Liquid Insured Deposits </li></ul></ul><ul><li>- Low maintenance, high-dollar, low-cost deposits </li></ul><ul><li>- Stable deposit gathering solution </li></ul>Reich & Tang Deposit and Liquidity Specialists SM
  43. 43. Wholesale Funding Solutions <ul><li>Let’s move to Collateralized Solutions: </li></ul>Repurchase Agreements FHLB Advances Federal Reserve Discount Window
  44. 44. Repurchase Agreement <ul><li>This is a borrowing that is in effect a secured loan transaction. </li></ul><ul><li>The dealer provides you cash in return for your providing high quality securities. </li></ul><ul><li>Depending on the length of the borrowing, your securities value will be 105% - 200% of the cash provided. </li></ul><ul><li>Given the uncertainty surrounding securities values, this market is not functioning well today for community banks. </li></ul>
  45. 45. Retail Repurchase Agreement <ul><li>Same concept but your customer becomes the dealer providing you with cash in exchange for collateralization of deposit. </li></ul>
  46. 46. Federal Home Loan Bank Advances
  47. 47. The Federal Home Loan Bank System <ul><li>Chartered by Congress in 1932 </li></ul><ul><li>12 regional FHLBanks, each an independently operated, member-owned cooperative. </li></ul><ul><li>Members include banks, thrifts, credit unions, and insurance companies; 8,057 members as of December 31, 2009. </li></ul><ul><li>AAA/P-1 credit-rated by Standard & Poor’s and Moody’s </li></ul><ul><li>Intended to ensure that financial institutions have access to adequate funds they can use to lend for mortgages. </li></ul>
  48. 48. FHLB Districts
  49. 49. FHLBank System Membership Composition FHLBank System Members 1990 2010 Savings Banks/ Thrifts 2,779 1,083 Commercial Banks 55 5,507 Credit Unions 3 1,030 Insurance Companies 4 227
  50. 50. The FHLBank System: How It Works Homes Community Investment Member Institution Investors FHLBanks Office of Finance
  51. 51. FHLBank System Financial Metrics ($ billions)   12/31/05 12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 Advances $620 $641 $875 $928 $631 $479 Investments $266 $271 $297 $327 $284 $238 Mortgages $105 $98 $91 $87 $71 $61 Other Assets $6 $6 $8 $15 $30 N/A Total Assets $997 $1,016 $1,271 $1,349 $1,016 $878 Capital-to-Asset Ratio 4.46% 4.43% 4.20% 3.81% 4.22% 5.00% Net Income $2.5 $2.6 $2.8 $1.2 $1.9 $2.1
  52. 52. FHLB Borrowing Structure: Three-Part Borrowing Facility <ul><li>Credit Line: </li></ul><ul><ul><li>Percent of assets (adjusts with changes in balance sheet) </li></ul></ul><ul><li>Collateral: </li></ul><ul><ul><li>Collateral type (SFR, MF, CRE, Securities, etc.) </li></ul></ul><ul><ul><li>Collateral arrangement (Blanket, Physical, Custody) </li></ul></ul><ul><ul><li>Collateral classes are fungible </li></ul></ul><ul><li>Stock: </li></ul><ul><ul><li>Membership stock + activity-based stock </li></ul></ul><ul><ul><li>Class A or Class B stock </li></ul></ul><ul><ul><li>Membership requirement = .50% of qualifying mortgage assets </li></ul></ul><ul><ul><li>Activity requirement currently = 4.50% </li></ul></ul>
  53. 53. The Federal Reserve System
  54. 54. Key US Programs and Actions <ul><li>Federal Reserve </li></ul><ul><ul><li>Interest on Reserves </li></ul></ul><ul><ul><li>New Programs </li></ul></ul><ul><ul><ul><li>Primary Dealers </li></ul></ul></ul><ul><ul><ul><ul><li>Term Securities Lending Facility </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Primary Dealer Credit Facility </li></ul></ul></ul></ul><ul><ul><ul><li>Money Markets, Consumer Credit and Housing </li></ul></ul></ul><ul><ul><ul><ul><li>Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Commercial Paper Funding Facility </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Money Market Investor Funding Facility </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Term Asset-Backed Securities Facility </li></ul></ul></ul></ul><ul><ul><ul><li>Bank, Thrift and Credit Union Funding Markets </li></ul></ul></ul><ul><ul><ul><ul><li>Term Primary Credit </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Term Auction Facility </li></ul></ul></ul></ul>
  55. 55. Closer Look: Lending to Financial Institutions <ul><li>Lending programs </li></ul><ul><ul><li>Primary Credit </li></ul></ul><ul><ul><ul><li>Lend funds (‘no questions asked’) on a short-term basis to institutions in generally sound condition </li></ul></ul></ul><ul><ul><li>Secondary Credit </li></ul></ul><ul><ul><ul><li>Lend funds (‘questions asked’) on a short-term basis to institutions that do not qualify for primary credit </li></ul></ul></ul><ul><ul><li>Term Auction Facility (“TAF”) </li></ul></ul><ul><ul><ul><li>Temporary program in which term funds are auctioned to institutions in generally sound condition </li></ul></ul></ul><ul><ul><li>Seasonal Credit </li></ul></ul><ul><ul><ul><li>Lend funds to institutions that can demonstrate seasonality in the lending and deposit-taking activities (limited to DI’s <$500MM total deposits) </li></ul></ul></ul>
  56. 56. Wide Range of Collateral Securities Loans Treasury 1-4 Family Agency Consumer Municipal Commercial & Industrial CMO Commercial Real Estate ABS Construction CMBS Agriculture Corporate Bonds Raw Land
  57. 57. Discount Window Website <ul><li> </li></ul><ul><li>Summary of Credit programs & Collateral Information </li></ul><ul><li>Federal Reserve Board Press Releases </li></ul><ul><li>Frequently Asked Questions (FAQs) </li></ul><ul><li>Acceptable Collateral and Margin Table </li></ul><ul><li>List of Reserve Bank contacts & phone numbers </li></ul><ul><li> </li></ul><ul><li>Detailed explanation of Credit & Liquidity Programs & balance sheet </li></ul>
  58. 58. In Summary <ul><li>We Will Always Like Core Funding and Will Use It So Long As It Is Efficient and Available. </li></ul><ul><li>But, There May Be Moments When Neither of Those Characteristics Are Present. </li></ul><ul><li>That’s When We Will Appreciate Understanding All of our Funding Sources! </li></ul><ul><li> Thanks! </li></ul>
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