Bank Board Letter August 2014 : Page 2

of real estate investing, where demand for owning buildings shifted to investing in private REITs and finally to invest-ing in public REITs, we sought an analogous structure for bank investments. This investment vehicle, StoneCastle Financial Corp. (NASDAQ: BANX, www.stonecastle-financial.com), is the first of its kind focused on investing in community banks. Investors get access to a diversified, exchange-traded community bank investment; in turn, community banks get access to a new pool of permanent, passive and reasonably priced capital. 2. Next, StoneCastle performs due diligence including man-agement interviews and background checks; and loan, secu-rity and deposit tape reviews. 3. The investment committee reviews due diligence informa-tion and determines if investment is suitable. Upon a unan-imous decision by the investment committee, StoneCastle then proceeds to final diligence and closing. 4. Upon approval, StoneCastle will execute a letter of intent, draft and sign definitive agreements, and invest funds into the bank. Thousands of eligible communiTy banks What kind of banks does StoneCastle Financial Corp. invest in? StoneCastle focuses its investments on community banks that have experienced management teams, stable earnings, sus-tainable markets and growth opportunities. Over the years we have found that smaller banks are reflections of their local mar-kets. Therefore we seek to avoid banks in challenged markets or banks heavily tied to one local industry. Some think small banks are risky banks, but history suggests otherwise. Since 1934, the worst failure rate for banks and thrifts was 3.2 percent in 1988, and our research has shown that there are more than 6,000 banks that are profitable and well capitalized with an average return on equity of 9 percent. long-Term capiTal parTner Many community banks with well-established franchises and cash-flow characteristics are not attracting capital from private equity or other institutional investors for a number of reasons. Many investors historically have avoided investing in com-munity banks due to the small size of these banks, their heavy regulation, Bank Holding Company Act ownership restrictions and the perception that community banks are riskier than larger financial institutions. In addition, many investors lack the nec-essary technical expertise to evaluate the quality of the small-and mid-sized privately held community banks. The StoneCastle team has been investing in community banks for more than a decade and is considered one of the largest in-vestors in community banks. Unlike private equity or many other institutional investors, StoneCastle views itself as a long-term part-ner that understands the needs of community banks. We believe that our flexibility to make investments with a long-term view and reasonable return requirements makes us the ideal investor for community banks and a solution to a $50 billion problem. Joshua Siegel is chairman and CEO of StoneCastle Financial Corp. For more information, visit StoneCastle-Financial.com. sTonecasTle’s four-sTep invesTmenT process Upon a bank’s indication of interest, the StoneCastle team will ini-tiate a four-step investment process: pre-screening, due diligence, investment committee analysis, and documentation and funding. 1. First is a pre-screen review of publicly available data to de-termine if proceeding to due diligence is warranted, and if so, StoneCastle sends a questionnaire to be completed by the bank. Reclassifying Deposits to Boost liquiDity By DaviD austin h istorically, it has been a challenge for financial institutions to accurately plan for future interest rate changes. Today, how-ever, banks are better equipped to do so due to new regula-tory oversight and the Federal Reserve Board’s guidance and qualitative assessment for rate change policy. According to the Fed, rates will most likely hold steady between 0 and 0.25 percent until 2016, even if the economy continues to stabilize and unemployment decreases. Fed Chair Janet Yellen has said the Fed is “committed to an appropriate accommodation to further stabilize the economy.” In recent years, the Fed’s “Evans Rule” set a targeted unem-ployment rate of 6.5 percent as the unofficial trigger to increase Next moNth: Working Smarter With Virtualization What Is Your Bank Really Worth? interest rates. However, having now hit that number, the Fed and the Federal Open Market Committee have stated that they will be monitoring more than just the unemployment rate when con-sidering an interest rate adjustment. As a result, the FOMC’s most recent statement indicated that interest rates will hold steady in the short run, but as the economy continues to strengthen, rates will inevitably rise once again. Given this, how can financial institutions better prepare for the future interest rate changes and identify op-portunities to create incremental revenue gains today? Every financial institution is currently sitting on liquidity, whether stored in its vault, on deposit at a correspondent bank or at a Federal Reserve bank. These funds are idling with minimal return as bankers wait for safe and short-term opportunities to present themselves. In other words, they are keeping their “powder dry.” Institutions simply do not have the level of margin that they have had in the past, but by strategically looking at fixed-income opportunities, for example, banks can create their own margins by accessing illiquid funds to deploy into revenue-generating income. Maintained reserve balances are a permanent non-liquid as-set. Although these assets are included in various regulatory ratio

RECLASSIFYING DEPOSITS TO BOOST LIQUIDITY

David Austin


Historically, it has been a challenge for financial institutions to accurately plan for future interest rate changes. Today, however, banks are better equipped to do so due to new regulatory oversight and the Federal Reserve Board’s guidance and qualitative assessment for rate change policy. According to the Fed, rates will most likely hold steady between 0 and 0.25 percent until 2016, even if the economy continues to stabilize and unemployment decreases. Fed Chair Janet Yellen has said the Fed is “committed to an appropriate accommodation to further stabilize the economy.”

In recent years, the Fed’s “Evans Rule” set a targeted unemployment rate of 6.5 percent as the unofficial trigger to increase interest rates. However, having now hit that number, the Fed and the Federal Open Market Committee have stated that they will be monitoring more than just the unemployment rate when considering an interest rate adjustment. As a result, the FOMC’s most recent statement indicated that interest rates will hold steady in the short run, but as the economy continues to strengthen, rates will inevitably rise once again. Given this, how can financial institutions better prepare for the future interest rate changes and identify opportunities to create incremental revenue gains today?

Every financial institution is currently sitting on liquidity, whether stored in its vault, on deposit at a correspondent bank or at a Federal Reserve bank. These funds are idling with minimal return as bankers wait for safe and short-term opportunities to present themselves. In other words, they are keeping their “powder dry.” Institutions simply do not have the level of margin that they have had in the past, but by strategically looking at fixed-income opportunities, for example, banks can create their own margins by accessing illiquid funds to deploy into revenue-generating income.

Maintained reserve balances are a permanent non-liquid asset. Although these assets are included in various regulatory ratio calculations, in practical terms these reserve balances are illiquid assets for a bank. By reclassifying transactional deposits under a deposit reclassification program, banks can tap into this found liquidity and choose to make a calculated risk with the funds that does not impact the liquidity positions already amassed.

Based on the Fed’s exit strategy from bond buying, the economy is creating opportunities now for banks to achieve gains that are better than fed funds rates, and the quickest, most cost-effective way to increase revenue and free up capital for more customer opportunities is through a deposit reclassification program. Deposit reclassification solutions enable financial institutions to lower their reserve requirements, free up illiquidity and subsequently transform it into liquidity on a permanent, recurring basis.

By reclassifying interest and non-interest-bearing transaction accounts into two sub-accounts Ð transaction and savings Ð for reserve computation purposes, a bank can report the majority of its transactional holdings back to the Federal Reserve as savings deposits. Money in a savings account is exempt from reserve requirement calculations, and as a result, deposit reclassification can free up these funds and transform them into liquidity, all the while maintaining minimum reserve requirements that can be satisfied with vault cash.

VALLEY REPUBLIC BANK IMPLEMENTS RECLASSIFICATION
Bakersfield, Calif.-based Valley Republic Bank, a $400-million asset community bank, was founded more than five years ago and, according to Stephen Annis, chief financial officer, there was no need for a deposit reclassification solution early in the bank’s existence. As the bank quickly grew, however, so did its reserve requirement, which required a new approach to managing liquidity.

“The internal and organic growth we have experienced quickly increased our reserve requirement to more than $10 million,” said Annis. “A handful of our staff had experience with managing deposit reclassification at other financial institutions, and we immediately began the search for one that seamlessly integrated with our core provider.”

The search led Annis and his team to Atlanta-based CetoLogic, a provider of cash management and deposit reclassification solutions for financial institutions. “CetoLogic’s Deposit Reclassification solution will recover somewhere between $8 million ± $10 million in reserve balances, enabling us to excel in our loan portfolio growth despite the industry trend of loan originations being down.” Annis continued that Valley Republic Bank’s plan for the recovered funds is to deploy them into local businesses and communities in Bakersfield and Kern County in Central California. “The deployment of our recovered funds will vastly improve our loan/deposit ratio and will subsequently improve our net interest margin and bottom line.”

FIRST LIQUIDITY, THEN WHAT?
Valley Republic Bank seized the opportunity and took advantage of the low-interest-rate environment to generate incremental levels of revenue. As interest rates remain low and financial institutions anticipate future change, some might be inclined to sit on their assets, simultaneously ignoring the opportunities currently available to them. Deposit reclassification solutions reclassify a portion of a bank’s transaction accounts as savings deposits to reduce reserve requirements. Because savings deposits are not subject to reserve requirements, banks are able to reclassify up to 80 percent of all transaction accounts and free up cash, which can then be re-deployed into loans and other higher-earning assets.

CFOs and investment officers are constantly mining their balance sheets looking for assets that are underperforming or holding business back. According to SNL Financial data, securities have grown to 21 percent of assets from 16.6 percent just four years ago (Q4 2009 ± Q4 2013). This data indicates that financial institutions are tapping into other fixed-income sources to generate income as exposure has been reduced from government agency securities. Financial institutions that tap into their Federal Reserve positions are accessing low-cost funds for lending or investing opportunities. As interest rates rise, so does the cost of funds, making a persuasive argument to take a preemptive step to accessing liquidity while it is still cheap.

Attractive positions for liquidity Ð despite lower rates Ð continue to be via securities or bonds. While the yield on bonds fluctuates and maturity terms can be lengthy, deposit reclassification enables banks to invest in these portfolios to take advantage of higher yields with calculated risk, while still preserving their liquidity positions for short-term opportunities when rates change.

The only constant relative of interest rates and liquidity is change. By leveraging deposit reclassification solutions, banks are better situated to improve their liquidity positions, regardless of what those changes may bring.

David Austin is vice president of Atlanta-based CetoLogic, a provider of software and analytics solutions for financial institutions and retailers. For more information, call 877-495-0687 or go to www.cetologic.com.

Read the full article at http://omagdigital.com/article/RECLASSIFYING+DEPOSITS+TO+BOOST+LIQUIDITY/1786111/221466/article.html.

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