Estimating Depositor Retention: A Common Sense Approach

Author: Joe Rezac, ALM Services Manager, jmrezac@profitstars.com

With football season coming to a close and the seasons changing, my attention has turned to my
winter hobby woodworking. Stepping into the shop after a long hiatus, Im always amazed by
the number of woodworking tools that Ive accumulated over the years. Despite this, many
different tools can often be used for the same job. A hand tool may offer more precision than a
power tool, but could take twice the amount of time to use.
Determining reasonable Asset-Liability Management (ALM) model estimates is a lot like
woodworking. There should be many tools in your toolbox when you work on your model
assumptions, helping you to achieve your goal of coming up with reasonable model results for
interest rate risk.
One ALM model assumption that has been in the spotlight recently is the deposit account decay
estimate. Until recently, the use of industry-derived decay estimates like those from the Office
of Thrift Supervision (OTS) or the National Economic Research Associates (NERA) were
standard practice in many ALM models and were not overly criticized. Simply using antiquated
industry standards are no longer going to cut it. There is no documented rule-of-thumb for what a
typical deposit accounts life should be, and there is little regulatory guidance for how to come
up with proper decay estimates other than the method used should reflect the size and
composition of your balance sheet. Since non-maturity deposit (NMD) balances play a
significant role on the liability side, coming up with a reasonable assumption for NMD life is
critical in fair value analysis.
Various approaches can be used to come up with depositor retention based on historical analysis.
One popular approach involves looking at a group of accounts that were opened and closed
within a particular timeframe and seeing how these account balances change relative to changes
in interest rates. But be careful. If you take this approach, dont stop there. Often this type of
analysis results in long retention times. The longer the retention time used for a deposit account,
the more of an implied premium exists in fair value calculations, which can skew overall fair
value results. Today, long deposit lives are facing strong examiner scrutiny. In many cases, the
financial institution simply uses their more rosy study results as a negotiation chip to go back to
using the old OTS/NERA decay estimates. When you end up scrapping the results of a thirdparty study that you paid good money for, thats an expensive lesson to learn! Equating back to
woodworking, thats like being told you cant use the new state-of-the art table saw you just
bought. Instead, you should revert back to using a hand saw, as its less likely to cut off your
fingers!

With increased examiner scrutiny a reality no matter which method is used, there are easier-tounderstand, less time-consuming, and potentially less-expensive options available. Which
options depend in large part on how much historic depositor data is accessible to you. Items such
as account open dates, close dates, average balances, and account types can be tracked over time
to begin to develop what the depositor behavior is for your institution. Ideally, at least one full
business cycle worth of data is needed. If you are limited on historic data, start with whatever is
available and track it going forward.
Again, dont stop there. Your deposit base is dynamic, so the process for tracking its ebbs and
flows also needs to be dynamic. Did your institution experience surge deposits since the 2008
financial crisis? If so, what percent of each account is represented by this group? Look at data
back over 10 years how many accounts are still open after years one, two, three, etc.? How
many are still open today? Now look back at the data over a five-year horizon what does that
tell you? What future events (either internal or macro-economic) will likely change depositor
retention from what it was historically? Repeat your process periodically to make sure the
information you get from the results stays current. Discuss with your Asset & Liability
Committee (ALCO) and examiner to see how the process can be fine-tuned to produce more
meaningful estimates.
Once a base set of assumptions is developed, consider estimating how the base assumptions
change when market rates change. Traditional statistical analysis has focused on how retention is
impacted when market rates go up or down. However, this disregards all of the other macroeconomic factors that go into a depositors decision to keep money parked at their financial
institution or close out the account and do something else with the money.
According to a 2011 J.D. Power & Associates study on U.S. Retail Bank New Accounts, the
number one reason people switch banks is life circumstances. Life events such as moving, job
loss, birth, death, marriage, and divorce all play a more critical role in a depositors behavior
than what current market rates are doing. But can this be properly accounted for in a rate-driven
model? An argument could possibly be made that the rate of heart attacks increases when market
rates drop 300 basis points overnight, but unless you have an actuary on staff, it may be difficult
to determine the precise correlation between the two. There is no easy button here. How much
of a factor rate plays in your depositor retention for each account type is something that your
ALCO needs to discuss, document, determine, and refine on a regular basis.
Depending on the size and complexity of your balance sheet, a statistically-based rate analysis
may still be part of your procedure for coming up with viable depositor retention estimates, but
other approaches should also be looked at as well. At the end of the day, are you comfortable
with explaining your methodology to an examiner or a volunteer board member? Whether its
used for regulatory stress testing or strategic planning, the tool that you are the most familiar

with (and is best designed to complete a task) is the one that will most likely achieve the best
results for you.