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By Kevin Martin
This year promises to be a challenging one for members as
the strong margins and deposit growth of recent years give
way to a flattening yield curve, sluggish deposit growth,
and variable loan growth. The additional cost of regulatory
compliance will also pressure earnings in 2005.
Many members will need to substantially grow their balance
sheets this year in order to meet earnings targets. Funding
this growth often leads management to offer CD rates that
are below the wholesale alternative but well above it when
marginal — rather than historical — cost of funds
is examined.
An institution is currently offering a three percent, one-year
CD special. The special attracted $5.0 million — $3.0
million in new money and $2.0 million moved from existing
product lines into the special. The member indicated that
the cannibalized funds were primarily derived from money market
and passbook accounts at a weighted average cost of one percent.
An examination of the marginal cost of funds reveals the
true cost of these funds:
| New
interest expense |
$150,000 |
($5,000,000 x 3.00 percent) |
| Cost
of existing deposits if the special was not offered |
$20,000 |
($2,000,000
x 1.00 percent) |
| True
cost of new funds |
$130,000 |
($150,000
- $20,000) |
| Marginal
cost of new funds |
4.33
percent |
($130,000
÷ $3,000,000) |
Borrowing from the Federal Home Loan Bank of Boston for one
year at 3.33 percent — rather than raising funds through
the 3 percent CD special with a marginal cost of 4.33 percent
— can result in a savings of $30,100. With margins already
under pressure, you can't afford to make a 100-basis-point
mistake. As rates rise and the difference between existing
core-deposit rates and those paid on specials becomes wider,
quantify the marginal cost of paying up for money that you
could have retained at a lower rate. If your institution decides
to offer a CD special, then monitor movements within existing
accounts and shut off the special if you experience significant
cannibalization.
Access to Bank advances allows members to minimize the cost
of funding at the margin. A model to easily calculate your
marginal cost of funds is available on FHLB Direct.
Please call the Money Desk at 1-800-357-3452 or moneydesk@fhlbboston.com
to let them know your funding requirements.
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