Pub. 4 2014-2015 Issue 1

22 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S FEATURE ARTICLE “A large quantity of core deposits allows banks to hold higher-yielding, longer-term assets without incurring undue interest rate risk.” BRIANMISCHEL SENIORMANAGER BKD LLP L oan demand has been low to moder- ate in many markets since the beginning of the 2008 liquidity crisis. Attracting and attaining core deposits during pe- riods of low to moderate loan demand can pres- ent both advantages and disadvantages to banks. Core deposit inflows bring regulatory com - pliance responsibility and can pressure asset yields and net interest margins during periods of Federal Reserve rate reductions due to soft loan demand. However, the advantages of attaining core deposits in a soft loan demand environ- ment often outweigh the disadvantages for most banks. Periods of slow loan growth provide op- portunities for banks to improve overall funding structure through balance sheet management. By definition, core deposits don’t bear inter - est, don’t reprice in tandem with market rates and reprice more favorably than market rates at the time of repricing. Accordingly, core de- posits are traditionally a lower cost of long-term funding directly affecting bottom-line profit. High-performance core deposits have a lower cost today, and their interest expense is more stable when interest rates rise. In general, core deposit inflows will positively affect the bank’s interest rate risk profile and bottom-line profitability by enhancing margins, noninterest income and—po - tentially—the bank’s ability to compete for and retain loan customers. Balance Sheet Management During periods of slow loan de- mand, increasing core deposits can allow banks to focus on overall balance sheet management. A strong foundation of core deposits reduces dependence on alternative funding sources such as brokered certificates of deposit and Federal Home Loan Bank ad- vances. Core deposits have a predictable cost, imply a degree of customer loyalty and are less interest rate-sensitive than alternative funding sources. Dependence on such noncore funding may constrain liquidity, heighten interest rate risk and subject a bank to increased credit risk to preserve interest margins. The overall fund- ing structure and loan-to-core deposit ratio can be significantly improved during periods of slow loan demand. The size and stability of core deposit positions affect asset and liability management risk. Periods of slow loan demand can allow banks to significantly reduce exposure to noncore funding risks. The net noncore fund- ing dependence ratio measures the degree to which a bank is funding longer-term assets with noncore funding. The following graph illustrates the recent noncore funding dependence ratio for all U.S. banks. Increasing values for this ratio generally indicate declining liquidity, as experienced by many banks in the liquidity crisis of 2008. The Value of Building Core Deposits Net Noncore Funding Dependence Percent 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Net noncore funding dependence ratio SourceSNL Financial Period