LIABILITY FORECASTS

For banks looking to do some deposit planning, we have updated our forecasts for 2007. Overall, liabilities will grow a little over 6%, a slower pace than 2006. For institutions looking to grow in excess of that number, plan on margins being further compressed, as there is little that can be done to prevent driving up cost of funds and making the bank more interest rate sensitive (although many tactics will certainly limit the degree of increased cost and sensitivity rise). Deposit growth is projected to slow due to competition from other alternatives (such as insurance and money market mutual fund products), as well as lower disposable income projections. Higher rates, inflation, slower sales and fewer cash-out mortgage refinancing will all affect cash balances held by households by an estimated 14%. As we look into different liability segments, expect another jump in wholesale funding to offset slower core growth. In particular, brokered CDs should be budgeted up, as they have added value in many cases over FHLB advances. For core funding, competition will continue to pressure rates higher, increasing funding costs for many banks. While most banks will remain fairly disciplined, the market will likely see greater competition for DDAs. Higher rates, more bells and whistles and a larger number of promotions will take place. As a result of higher costs, DDA volume growth is expected to increase 8%. This trend of greater promotions has already occurred in MMDAs, as we have seen unprecedented competition. Long an overlooked portion of liabilities, 2006 saw the largest jump in MMDA rates in the last several years. Banks that never paid more than 20% of Libor for such accounts have begun paying as much as 95% of Libor for larger balances (usually over $50k). Expect this trend of tiering rates by deposit amount to not only continue, but for some of the best rates to be paid on amounts as low as $25k. On the CD front, competition will abate somewhat, particularly past 2Y. This will occur as fewer banks take the risk of having high priced money locked-in, given the potential for lower interest rates. In addition, banks have shown more discipline in pricing in the last several months after largely panicking due to shrinking margins. As such, expect most of the issuance to remain within 18 months and slightly lower pricing to take hold over time as sanity and lower loan activity take hold. This should result in lower CD growth, probably around the 4% range. As for duration, look for maturities to shorten, but for effective duration (the measure of interest rate sensitivity) to increase by about 2 months (as non-maturity balances increase and banks have greater success at adding less interest rate sensitive balances). Finally, 2007 will go down as a similar year to 2006, albeit slightly more challenging. Greater competition and sophistication will continue to raise the bar, causing many banks to take a closer look at both products and offerings.