Pub. 5 2017 Issue 4

Issue 4. 2017 13 Stand Pat or Pay Up A fter several Fed hikes having already taken place, retail deposit cost increases has thus far been marginal. However, with multiple additional hikes being projected to take place by the end of 2018, that could soon change. Each hike increases the likelihood that your competitor down the street may raise rates to get new deposits in the door. If and when this happens, will you follow suit? After all, even retail deposits at an increased rate provide you with cheaper funding versus the wholesale market. Is it really that simple though? Are you better off raising your rates to compete with the special offer of your competition? If the pro- motional retail rate is significantly cheaper than the wholesale alternative, the eye test certainly tells you so. However, using marginal cost analysis can tell a very different story, as basic math can show the hidden cost of raising retail deposit rates can be quite steep. Let’s consider the scenario where competitors are increasing rates on one-year CDs and you need to evaluate whether or not to respond in lockstep. In this type of analysis, you need to estimate the percentage of your institution’s maturing one-year time deposit accounts that will move to the competition unless you match the competition’s rate. This percentage is defined as the rate sensitive portion of that segment of the deposit base. Table 1 shows the rate sensitive and non-rate sensitive portions of the maturing one-year CD accounts for our hypothetical institution. Here we assume that 45 percent of the account holders are rate sensitive. Table 1. Rate-Sensitive and Non-Rate Sensitive Portions of Maturing One-Year CD Accounts Deposit Type Amount Rate Cost Non-Rate Sensitive 5,500,000 0.40% 22,000 Rate Sensitive 4,500,000 0.40% 18,000 Total 10,000,000 0.40% 40,000 The factors to consider in this analysis consist of the following: current deposit rate, promotional rate and the cost of replacement funding. Some would assume that if the promotional rate offered is lower than the replacement funding rate, then increasing deposit rates is the best option. The marginal cost approach shows that isn’t always the case. Let’s assume that we raise rates in order to retain the maturing deposits. Table 2 shows the marginal cost of the “pay-up” strategy. Table 2. Marginal Cost of Increasing Rates to Retain Deposits Deposit Type Amount Rate New Rate Rate Increase Marginal Cost Non-Rate Sensitive 5,500,000 0.40% 1.25% 0.85% 46,750 Rate Sensitive 4,500,000 0.40% 1.25% 0.85% 38,250 Total 10,000,000 85,000 Marginal Cost 1.89% By Brandon Casey, Federal Home Loan Bank of Des Moines