Deposits - Core Factors

Core Deposits accounts (DDA,NOW, Savings and MMDA) comprise a large part of a banks funding, especially in a community bank.  Questions begin to emerge on how to model the deposit behavior in terms of sensitivity to market rate changes and maturity structure for valuation.

Core Deposit accounts typically have administered rates, meaning the rates change when the powers that be at the bank say they change.  We do know however that there is often some response to market rate changes.  To model this sensitivity we use a Core Deposit Repricing Beta factor. This is the percentage of rate change each account will move with a 100 basis point movement in Fed Funds. 

For example, if Money Market accounts are extremely rate sensitive and perhaps even tied to the Fed Funds rate, the Core Deposit Repricing Beta factor is 100%; Money Market accounts move step in step with Fed Funds. 

Let's look at another example.  If you have not moved the rate on your savings accounts in the last 10 years, the Core Deposit Repricing Beta factor would be 0%, or no sensitivity to movements in Fed Funds.  These are extreme examples and most accounts behave somewhere in between these extremes. 

Also remember that the Core Deposit Repricing Beta factors are not always symmetrical in the rates up and rates down scenarios.  Bankers will move rates down as quickly as possible (more sensitivity to market rate changes and a higher core deposit beta factor) while delaying an increase in the rates on core deposits as long as possible (less sensitivity to market rate changes and a lower core deposit beta factor).  Here is a related post that talks about Core Deposit Beta factors.  And another one here.

In order to calculate the Present Value on an account we need maturity structure of the cash flow.  This presents a particular problem with accounts that have no contractual maturity.  In the case of Core Deposits, we use a Decay Assumption to show how the accounts behave in terms of maturity.  There are four choices for decay assumptions:

1)  FDICIA 305 (default assumption) 

This was proposed by FDICIA over a decade ago and never adopted for several reasons, primarily because the behavior of these accounts in terms of "maturity" varies widely from bank to bank depending on size, location, age, marketing strategy et cetera.   FDICIA 305 tends to produce shorter (modified) durations, typically 1.6 to 1.7 years.  To the right you will find the decay assumptions proposed by FDICIA 305:

2)  OTS NPV

The OTS uses their own formula to determine Net Present Value (NPV) for all Thrifts and the (modified) duration using the OTS formula tends to be longer than the FDICIA 305 proposal, typically over 2 years.

3)  3rd Party data

There are a few vendors who will do an account analysis of your core deposits and calculate a decay rate for each account (DDA, NOW, Savings and MMDA).  This methodology is very precise but also very expensive.  You can supply this data via our secure upload site.

4)  Custom Decay

This is the preferred method of examiners if you do not use a 3rd Party analysis.  Clients internally calculate a decay structure by analyzing the average life of their core deposits, typically done by using a five year history of closed accounts.  This can be difficult due to the purging of closed accounts but you can begin by collecting this data now.  Once the analysis is complete, you can provide this information here.

More reference on Decay Assumptions can be found here.

Comments

[R. Holt]

Good morning. Thank you for this resource. As I have been researching off and on for days, I appreciate your discussion. I was curious if you could point me to a regulatory reference online that includes the FDICIA305 default assumptions. Thank you for your assistance.