Pub. 4 2014-2015 Issue 1

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 July • August 2014 23 Higher ratios reflect a reliance on funding sources that may not be available in times of financial stress or unfavorable market changes. The cost of core funding in recent years adjusted nomi- nally in response to market movements, showing that the cost of core funding is less likely to react unfavorably than noncore funding during adverse business conditions. The following graph illustrates the recent cost of funds for different products at all U.S. banks. A large quantity of core deposits allows banks to hold higher- yielding, longer-term assets without incurring undue interest rate risk. Higher-paying deposits attract “hot money” that may quickly leave the bank if rates are reduced. High levels of stable core deposit funding provide an institution significant control over its interest rate risk profile and reduce interest rate risk. Bank regulators consider the strength of core deposit positions in assessing a bank’s overall interest rate risk profile Multibank Holding Companies Multibank holding companies have unique opportunities to manage their balance sheets. Loan demand for banks within a multibankholding company canbe shifted frombankswith exces- sive loan demand to others with minimal loan demand through sales or participations. Subsidiary banks with a stronger base of core deposits can fund liabilities for other banks in the group. Such transactionswithin amultibank holding company can create efficiencies, reduce risk and increase the potential for earnings. Supplementing Retail Banking Product Development Core deposits represent reliable sources of fee income and opportunities to cross-sell other products. High-performing banks typically develop and market other products to enhance core deposits and offer their customers a greater variety of products and services. Most banks perceive this broadening of products and services as essential to remain competitive with other bank and nonbank competitors. For example, many banks offer cashmanagement services for business customers as well as remote deposit capture, insurance services, repurchase agreement-related products and other point-of-sale products. These products also serve to compete for and retain loan cus- tomers. Ultimately, inflows of core deposits breed a customer base, which generates noninterest income through increased transaction volume, related retail banking product sales and eventually an increase in loan customers. Community banks rely heavily on customer loyalty to obtain business and build loyalty through multiple relationships. Considering Customer Demographics The demographics of the bank’s customer base can affect loan demand market share between competitors in the same market. Focusing on the demographics of core deposit customers can enhance the bank’s ability to compete favorably and retain customers, including profitable loan customers. Focusing on the bank’s market demographics and offering products that compete favorably for desiredmarket segments can help a bank addmar- ket share as loan demand returns. A bank can use a variety of implicit and explicit pricing structures for its core deposit prod- ucts, including tailoring product features and pricing to attract a customer base with more desirable demographics in periods of increasing loan demand. For example, a bank may waive cer- tain account fees for retail customers who maintain minimum balance requirements. Commercial customers may be given an “earnings allowance” for demand deposit balances kept in lieu of paying account fees. A bank also can tier pricing strategies to segregate a bank’s customer base between high-balance, rate- sensitive customers and low-balance, rate-insensitive customers. Increasing Franchise Value Core deposits are a significant factor in determining a bank’s overall franchise value. The value of core deposits or the core deposit intangible can be a significant factor in determining the bank’s market value. Premiums paid for core deposits in acquisi- tions or mergers historically have been significantly higher than those paid for loans. Banks typically are sold and valued based on amultiple of earnings. An earnings streamenhanced by a strong core deposit base increases the value of a bank. High premiums paid in bank transactions typically are the result of substantial core deposits developed and retained through deposit relation- ships and retail funding. Although the tangible book-premium- to-core deposits in bank acquisitions vary from deal to deal and period to period, banks have realized significant premiums paid on core deposits. Thus, enhancing core deposits builds up a sub- stantial off-balance sheet asset, which can be realized through the sale of branch locations or the whole bank itself. The current environment may generate a negative spread on deposits for some banks because of soft loan demand. However, the competitive, risk management and profit enhancement ben - efits of building core deposits ina low tomoderate loandemand en - vironment far outweigh the drawbacks. Developing a strong core deposit base will better position banks for long-term success. n This information was written by qualified, experienced BKD professionals, but apply- ing specific information to your situation requires careful consideration of facts and circumstances. Consult your BKD advisor before acting on any matter covered here. Article reprinted with permission from BKD, LLP, bkd.com. All rights reserved. Source SNL Financial Cost of Funds Cost 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Interest bearing transaction accounts Savings deposits Other time deposits Time Deposits > $100K Fed Funds purchased and repos Other borrowings