Non-Maturity Deposit Analysis

Forecasting non-maturity deposit behavior is difficult because they contain two embedded options:

• The financial institution holds the option to determine the interest rate to offer the depositor, while;
• The depositor holds the option to withdraw all or part of the account balance at par.

As a result, we approach our non-maturity deposit analyses holistically. We begin with a review of the financial institution’s financial performance for the most recent 10 years to better understand its business philosophies, operating procedures, and tolerance for balance sheet risk. We then review the performance history for each account, considering the organization’s strategies regarding account design and offering rate.

We benchmark our findings to our overall industry performance studies and cost estimates. We summarize our work and recommendations account-by-account and make recommendations in the context of the organization’s goals.

We believe that a review of ALM modeling should be comprehensive and performed in the context of our client’s policies and procedures and recent financial performance. Our model validation begins with a thorough review of our client’s ALM policies and procedures to better understand our client’s goals, objectives, and risk tolerances. Next, we review our client’s financial statements for at least the past 10 years to understand the institution’s recent financial performance.

After gaining the appropriate context for our review and recommendations, we begin our thorough review of our client’s existing ALM model and Asset Liability Committee (ALCO) reports.

We help financial institutions develop non-maturity deposit ALM input assumptions for expected depositor behavior and future deposit rates.

Assumptions include:

• Re-pricing beta – the magnitude of change that a financial institution would likely make in response to changes in market interest rates;
• Effective maturity – the estimate of when the last cash flow for an account type is projected to occur; and
• Decay – the rate at which balances are being reduced from the account base.

To quantify the pricing option, we perform a linear regression analysis of the rates offered on a class of non-maturity deposits compared to an appropriate market rate benchmark. This analysis allows us to estimate the re-pricing beta and shows the magnitude of the change our client would likely make in response to changes in market interest rates.

We model account persistency by analyzing how the accounts have performed in the past. Our analysis includes estimates for effective maturity and for decay.

The effective final maturity indicates when the last cash flow for an account is projected to occur. To estimate effective maturity, we first calculate the average account balance.

We then perform a regression analysis, modeling the spread between an appropriate historical market rate benchmark and our client’s deposit rate, versus the average balance for the account type. The outcome, or R-squared, that results from this regression provides a measure of how well changes in average balances are explained by changes in the spread of our client’s deposit rate to the market rate benchmark. Accounts with high correlations are expected to have short final maturities, and vice versa.

We perform our decay rate analyses using one of two methods:

1. Account number method: We begin with a set of accounts and balances. These accounts are then tracked to determine what happens to the balances over time. In the process, no new accounts are considered.
2. Origination date method: This method compares beginning and ending balances of all accounts by account type and takes new accounts into consideration to determine a decay rate. Account numbers are generally not needed for this method.