Risk Management & Analytics: Deposit Behavior Is Unpredictable as Rates Keep Rising

Deposit Behavior Is Unpredictable as Rates Keep Rising

As interest rates continue to move up, no blanket predictions can be made about the near- or long-term behavior of non-maturity deposits at financial institutions nationwide. Moreover, deposit behavior will vary significantly among product types and institutions, depending on a bank or credit union’s customer base and product mix.

These are the two main themes of a presentation being given June 11 by representatives from MountainView Financial Solutions, a Situs company. The presentation is being given by Della Zheng, director of analytics, and Anthony Eramo, managing director, at the Financial Managers Society (FMS) Forum in Orlando. The educational event for finance and accounting professionals from community banks, thrifts and credit unions is produced by FMS.

Deposits provide the funding for loans and other assets, so financial institutions need accurate expectations of deposit lives to match with their assets. While loan prepayments generally go down when rates are rising, retaining and properly pricing deposit products becomes more difficult.

“The question being asked across the banking industry is how deposits are going to generally behave, and the truth is that nobody knows what’s generally going to happen,” says Zheng. “With that said, by looking at deposits at specific institutions, we can more accurately forecast behavior.”

According to Zheng, there are very different historical behaviors among deposit products and institutions. She explained that checking accounts can be very different from money market accounts, and one institution that focuses more on retail deposits can be very different in terms of the same product’s behavior compared to another institution that focuses primarily on business customers.

In his interaction with clients, Eramo says he emphasizes the importance of knowing the lives of each category of their deposits for liquidity planning and identifying surge balances. “A liquidity problem is like a heart attack – it can kill you immediately,” he explains.

In a potential signal of a regulatory focus coming out of a historically low rate environment, Eramo said the current overall sentiment he has heard from banks is that regulators are starting to ask more often for the backup behind assumptions on lives and betas for non-maturity deposits.

With all of these considerations in mind, MountainView is advising clients to obtain an institution-specific study of deposit behaviors. Given the uncertainty ahead, institutions need a forecast now more than in a normal economic environment. A scenario analysis will ultimately be a guide that sets pricing strategy going forward.

It’s 2007 Again for Commercial Mortgage Bonds, Moody’s Says

Commercial mortgage bonds are getting stuffed with the lowest-quality loans since the financial crisis by one measure, according to Moody’s Investors Service, a warning sign that the $517 billion market may be headed for harder times.

The securities are backed by as many interest-only mortgages as they were in late 2006 and early 2007, Moody’s said. Those loans are riskier because borrowers don’t pay any principal early in the debt’s life. When that period expires, the property owners are on the hook for much higher payments.

The percentage of interest-only loans in a commercial mortgage bond is an “important bellwether” for the industry, according to Moody’s analysts, because the loans are more likely to default and to bring bigger losses to lenders when they do. Underwriters aren’t taking steps to fully offset the rising risks, the ratings firm said.

Read more: Bloomberg

Shifting the Risk of Mortgage Defaults From Taxpayers To Investors

Since the financial crisis, the federal government has vastly expanded its role in backing the residential mortgage market. While today’s outstanding balance of single-family mortgage debt is slightly below the 2008 peak of $11 trillion, the portion of the new home mortgages guaranteed by government sponsored enterprises (GSEs) and related federal agencies now exceeds 70%, as compared to approximately 35% in 2006.

These statistics raise important policy questions about the US government’s role in supporting the home mortgage market during normal times and in housing recessions. After the financial crisis of 2008, taxpayers have rebelled against bailing out financial firms in the mortgage market. Yet, public officials still endorse government subsidies to help achieve the social benefits of homeownership.

So, Congress is not likely to muster a bipartisan majority to pass any of the proposed legislative reforms. At one end of the spectrum, some Republicans have called for the re-privatization of the GSEs, on the assumption that the mortgage market could function without any government guarantee. At the other end of the spectrum, some Democrats want to treat GSEs as public utilities owned or regulated by the federal government.

Read more: Brookings

Three Ways Real Estate Asset Managers Can Minimize Interest Rate Risk

When wages showed strong growth earlier this year, it sparked investor concerns that the Federal Reserve will pick up the pace of interest rate increases. It led to a stock market selloff as investors panicked about whether higher borrowing costs would cause lower corporate profits. It also calls to mind the fact that private real estate is equally susceptible to rising rates.

It’s an open question whether higher interest rates will reduce commercial real estate’s inherent stability. Outgoing Fed Chair Janet Yellen came short of proclaiming a real estate bubble in a February CBS interview, noting that commercial values are near the high end of their historical ranges but seeing little threat from a decline.

Even so, skillful real estate asset management is all about managing risk, and a changing interest rate environment is no exception. Here are three ways investors should expect asset managers to minimize the impact of rising interest rates:

  1. Give deals a stress test.
  2. Use debt responsibly.
  3. Keep selling options open.

Read more: Forbes

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