HIGH RATES FOR CONSUMERSPRODUCE HIGH ANXIETY FOR BANKERS

Updates to the FDIC's Section 337.6 for Deposit Rate Limits Take Effect January 1, 2010

By Joseph BartolottaMarketing Strategy Principal, CAMELSolutions LLC

A change to FDIC Section 337.6 takes effectJanuary 1, 2010 and restricts deposit ratesoffered by "less than well-capitalizedinstitutions" to "not significantly exceed theprevailing rates in the applicable marketarea." While the intent of the rule change isclear - to prevent banks that are already infinancial distress from paying more fordeposits than they could prudently afford -these relatively simple phrases can presentsignificant implementation challenges for thebanks they are aimed at - and significantopportunities for others.

The phrase "less than Well-Capitalized"means that the new rules apply to a broaderset of banks than one might expect. Eventhose institutions whose capital ratios exceedminimum requirements are affected by thisrule change if they are subject to a capitalmaintenance provision as part of a consentorder, C&D order, capital directive, promptcorrective action directive, or other similarwritten agreement by their regulator. "WellCapitalized" by the numbers can still mean'Adequately Capitalized' for purposes of thisrule.

gauged against similar products in themarketplace (i.e., money market accountscompared to money market accounts, CDs toCDs, etc.), based on consistent definitions ofaccount tiers (i.e. 'jumbo CDs' are those withminimum balances greater than $100,0000),and based on similar maturities. Where agiven bank's product doesn't have a directmarketplace counterpart - for example, an 8-mth CDwhen all other banks are offering only6· or 12-mth products - the appropriate ratewill be inferred using a very simple linearinterpolation technique. Finally, using allthese criteria the rates from the subject bankwill be compared to the average of others inthe marketplace, and its rates cannot exceedthe average by more than 75 BP. The newregulation even includes references to how

promotional /teaser rates, giftoffers, and other

traditionalpromotional

tools that areused in lieu ofpure rates arefactored into thecomparison.

What's in a name?

And where exactly is 'Here' ?How high is 'High'?

This part of the puzzle has already been madevery clear: the FDIC has implemented byregulation the statutory language"significantly exceeds" as meaning 'more than75 basis points higher'. But higher thanwhat? And where?

The definition of 'applicable marketplace' ismuch less well defmed. The starting point is anational average of rates from all insuredinstitutions for a given product. That averagewill be published on the FDIC's website.

The 'what' is fairly clear: institutions subjectto this rule will have their product offerings

Obviously, a national average incorporates avery broad range ofmarkets and institutions, soit's possible that such a constraint could make a

subject bank very uncompetitive ill itsparticular market area.

Upon request, 4 product types (money marketdeposit account, l z-month, 24-month and 36-month CDs in amounts less than $lOO,OOO)will be reviewed to determine if a subject bankis operating in an area where the nationalaverage is not a true indicator of the localmarketplace. If the standardized rate data forthe bank's market area exceeds the nationalaverage for at least three of these fourproducts by at least 10 percent, it can be saidthat the subject bank is indeed operating in ahigh-rate area.

The text of the regulation shows examples of'market area' defined at the state level, at theMSA [metropolitan statistical area] and MicroSA [micropolitan statistical areal. The lattertwo are Census bureau definitions that definepopulation centers based on the number ofpeople and on their commercial and socialinteractions, and together describe about 95%of the U'.S. population. MSAs and Micro SAsdon't line up exactly with city, county or ZIPcode boundaries - so you will very likely needto translate your existing trade area map intoone of these definitions.

Determination Isn't Implementation

So then what? If a bank is recognized asoperating in a high-rate area, then its ratescan be gauged against the average of otherbanks in that area for compliance with the 75BP differential, which presumably will allowit to price more competitively against thoseinstitutions. But, what happens if thenational average would allow better pricing onone specific product? Unfortunately, it's anall-or-nothing proposition: the bank can electto use the local-market approach, or use thenational average - but once that selection ismade, it applies to all products. So you willneed to very carefully assess which productfs)are most important to your deposit gatheringefforts at a given time, then compare yourtarget rate to both the local market area andto the national average, and then determinewhich approach would best suit yourinstitution.

The high-rate local market determinationremains in place for the calendar year inwhich it was made; the institution can requestanother calculation to determine if the high-rate status remains in place for another year.Banks can request a determination from theFDIC at any point in the year, but 30 daysadvance notice is required - so responses tocompetitor price changes won't be as rapid asthey were in the past unless you plan ahead.

If your bank operates a website and uses it togather deposits from outside your marketarea, offered rates on those deposits mustutilize the national average rate forcompliance with the 75 BP limit. If it hasbeen determined that your bank operates in ahigh-cost area, those higher rates wouldpertain to locally-gathered deposits, and thenational rates would apply to internet-sourceddeposits - right? Wrong: the local marketapproach would apply to all locally-gathereddeposits, even if a consumer in your localmarket area chooses to transact via yourwebsite.

Which means that you may need to providetwo sets of rates on your website - and yet willwant to do it in such a way that consumerscan't see both sets of rates side by side. Thereare a variety of techniques to accomplish thistype of location-specific pricing which makethe presence of multiple rates invisible to theconsumer.

How Do I Get Started?

The updated Section 337.6 rules must beintegrated into your pricing strategy.Determine where your offered rates need to beto generate the deposit volume specified inyour profit plan, and compare those rates tothe FDIC's national average. If they exceedthat number by more than 75 BP, simulateyour own local market rate determination tosee if your bank is likely to be operating in ahigh-rate market. Before you request anofficialdetermination from the FDIC, examinethe difference between national and localmarket rates for each product - paying closeattention to the productfs) that are mostcritical to your success. Given the complexityof this analysis, the use of Census-driven

market definitions and the need for rapidcompletion, you may want to considerengaging a third-party firm that can offerguidance in this type of decision process,and/or complete the analysis for you.

Thanks, But This Doesn't Apply ToMe ...

As we've already seen, this new rule set isn'tlimited to undercapitalized banks: even withratios above minimum requirements, if you'reoperating under any kind of regulatoryagreement you're likely affected by the ratecap. So,you're well capitalized and free of anywritten agreements? Congratulations - butnow is not the time to rest on your laurels.Most likely there is one or more institutions inyour market area subject to the deposit ratelimit - and this is your opportunity to capturesome deposit share while your competitorssort out this new rule.

Most banks will take some time to workthrough the particulars, and more time toimplement their solution. Many won't eventry - and simply limit their offered rates towithin 75 BP of the national average. With arelatively small rate differential you can putsome distance between your bank and theseothers - and know that they won't soon becountering your move with an increase oftheir own.

Lemonade from Lemons: Use ThisRule To Your Advantage

So there are two sides to this rate cap: if yourbank is subject to the limitation, you need toreact - quickly - by determining whether andwhere a 'high-rate market' exclusion exists,obtaining the exception from the FDIC, andpromoting those rates in your marketingefforts.

If you aren't subject to the cap, then targetthose competitors who haven't heeded thisadvice, and price aggressively to garner someshare while their actions are hindered. Eitherway, the changes to Section 337.6 should besomething your competitors worry about - notyou.

Joe Bartolotta is the Marketing Strategy Principalat CAMELSolutions, LLC - a banking consultancythat helps clients improve their CAMELS ratingand increase shareholder value. Email him atjoe.bartolotta@camelsolutions.com orcall (800) 349-4709