Surge Deposits: Straight Up with a Twist

twist orange peel
Dave Wicklund Photo
Director of ALM Advisory Services

5 minutes

How does a financial manager keep a realistic pulse on members’ ‘outgoing surge behavior’?

For the past few years, I’ve written about the varying circumstances surrounding surge deposits. From “the death of” to the “resurgence,” it seems to be a consistently hot topic—this year, with a slight twist. 

While we were previously keeping a close watch on the influx of non-maturity deposits, we’re now seeing increased pressure on funding flowing either from these NMDs into higher-costing CDs or out of financial institutions altogether.

Surge Deposits, Defined

Before we get further, let’s quickly recap what surge deposits are and why they have such a significant impact on credit unions. Surge deposits are an abnormal influx of funds due to volatile extenuating circumstances within the economy that affects the predictability of the funds’ longevity or stability within your financial institution. 

Surge Deposits in Recent History

In early 2020, I wrote a blog declaring the end to, or “the death of,” surge deposits. In that post, I had noted how at the time of and following the 2007-2009 Great Recession, the banking industry saw a substantial influx of deposits as real estate and equity investors liquidated positions and sought safe places to store their money and ride out the storm. I further noted that as CD rates plummeted during and following the economic crisis, CD holders weren’t being provided with any incentive to have their money “locked” into time deposits. As time deposits matured, CD holders routinely moved their balances into more liquid NMDs. These former CD holders were essentially temporarily “parking” their money in NMD accounts, waiting for CD rates to return to what they believed were more “normal” levels, at which time they’d move the balances back into time deposits.

Given the potential liquidity and interest rate risk associated with those surge deposits, regulators expected banks and credit unions to review their deposit composition, identify potential surge deposits and consider the risk(s) associated with them. In that early 2020 article, however, we highlighted that in late 2018 and into 2019, we saw a market-wide spike in CD rates, and it was not uncommon to see one-year CD rates of nearly 2.75% and five-year CD rates of 3.25% or more. At the same time, most financial institutions left NMD rates at, or near, their historic low levels, which should have been more than enough incentive for surge depositors to move their “parked” funds back into CD products. The whole point of the article was to highlight that any former “surge” balances still left in NMD accounts at that time should no longer have been considered “surge” or be viewed as having increased volatility characteristics, thus ending the “surge deposit” era.

However, in mid-2020 and 2021, a new era of surge deposits emerged as a result of the pandemic; let’s call it Surge 2.0. So, what is Surge 2.0? 

Well, it’s what happens when the federal government injects trillions of dollars of cash into the U.S. economy. And no matter how you feel about the various pandemic-related stimulus packages, the fact is that the bulk of that cash found its way into banks and credit unions everywhere. We saw deposits at most of our clients’ institutions grow by at least 10% and as much as 20% in 2020. That’s more than a “surge”; it’s a tidal wave, and just like that first era of surge deposits that followed the Great Recession, these 2020 and 2021 surge deposits were a great low-cost funding source. But, now that Treasury rates and deposit rates in most markets have skyrocketed, higher-yielding alternatives are again abundantly available to depositors, and we’re starting to see non-maturity deposit balances at many of our clients beginning to decline.

Because rates continue to rise and consumers now have a variety of attractive investment options, financial institutions are presented with the challenge of predicting customer behavior. Will they keep their funds in the same NMD accounts that they’ve been sitting in? Will they opt for an attractively priced CD at the same institution? Will they move their funds to another organization altogether? Or will they venture to the U.S. Treasury market, stock market, or some other alternate investment opportunity? 

In 2023 and beyond, the options are seemingly endless, and you can bet that regulators will be looking closely to see what you’ve done to assess their stability, and more specifically, what adjustments, if any, you’ve made to the decay rates you’re using in your interest rate risk model.

With so many options, attempting to anticipate customer behavior is no small task. So, how does a financial manager keep a realistic pulse on the impact of this outgoing surge behavior on the liquidity, cash flow and interest rate risk positions of the financial institution?

Surge Deposits: 3 Regulatory Expectations

  • Consider the effect of surge deposits when setting decay rate assumptions
  • Analyze their possible impact on liquidity as part of your regular stress testing and cash flow modeling
  • Assess the potential impact on funding costs

The ultimate resolution is the same as it’s been—you need to know and account for the level of surge deposits in your funding base, and a surge deposit analysis is the first step in doing that.  

Regulatory guidance states that as part of formulating decay rate assumptions, “banks should consider adjustments for qualitative factors to reflect current-period market conditions and anticipated customer behavior in response to interest rate fluctuations, for example by adjusting [for] the assumed runoff of surge deposits.” You may also be asked to expand your cash flow modeling efforts to include a stress scenario to show the potential run-off of these newfound deposits.

If you haven’t yet reviewed your deposit base and quantified the level of potential of deposit runoff, we can do it for you (and it’s not expensive). You'll get complete documentation, including a 15-year deposit trend analysis, and then we’ll show you how to use the results to adjust your decay assumptions and cash flow modeling scenarios.

Dave Wicklund is director of ALM advisory services at Plansmith, a CUES Supplier member. Have questions or ready to get started with an analysis? Email us and we can schedule a time to talk.

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