CASE HISTORY: RESERVE MANAGEMENT                         First National Bank, Hudson, Wis.

Companion accounts cut sterile reserves
By Steve Cocheo, executive editor, ABA Banking Journal — November 2001

Sterile reserves tie up dollars that could be doing something productive for a bank and its community. Large banks have been able to manage their required reserves for some time, but it's been a bigger challenge for many community banks.

A bigger challenge, but the payoff can also be vast. Ken Heiser, president and CEO of $290 million-assets First National Bank of Hudson, Wis., pointed out that his bank was maintaining Fed balances of $788,000 in August 2000. By reducing required reserves, this came down to $48,000 in August 2001, a manifold drop. And yet, comparing the same periods, the bank's total deposits rose by $36 million. Heiser expects that reserve reduction will, on an ongoing basis, free up roughly $1 million in investable funds. Even at today's lower investment and lending rates, that is a tremendous benefit obtained for comparative pennies.

Hold the average down
Governed by the Federal Reserve Board's Regulation D, reserves must be held in the form of vault cash, balances, or pass-through accounts, which are considered the equivalent of Fed deposits.

Required reserves are based on a daily average of deposit balances over a given reporting period, the period and the frequency of reporting varying by bank size. Under the Monetary Control Act of 1980, transaction accounts and certain other deposits are subject to reserve requirements, broadly speaking.

With the required reserves being based on average balances, it is to a bank's advantage to hold down the balances on enough days to bring the average down. However, availability of transaction balances to customers, as demanded, is also necessary.

So, what's called for is a way to push funds out of accounts covered by reserve requirements, without compromising availability, all the while not running afoul of the banking rules and the Fed's FRB 2900 reporting form.

"The big banks have been doing this for years," says Heiser. First National's challenge was to find a practical way to do the same thing in a community-banking environment.

Getting the transformation done
Federal banking rules permit banks to set up companion savings accounts for transaction accounts, including both straight demand deposits as well as interest-bearing negotiable order of withdrawal accounts. The trick is to maximize the benefit of making transfers into the companion accounts (which don't have reserve requirements) without leaving customers bereft of funds in their transaction accounts. In addition, if the companion account is set up as a money-market deposit account, there are limitations on the number of transfers made in a month that must also be observed in order to enjoy the exemption from reserves.

This all required a sophisticated adaptation of the sweep account concept, spread among the bank's approximately 15,000 business and consumer transaction accounts. To accomplish this, First National selected ReserveLink, a software package from Carreker Corporation, Dallas, Texas. There are competitive products out there that the bank also looked at, according to Paul Moen, senior vice-president and chief financial officer, but the bank ultimately opted for ReserveLink because it runs on the bank's IBM AS/400 computer. The other package that the bank had considered runs on a personal computer. (ReserveLink runs on a variety of additional platforms too, including IBM MVS and DOS/VSE, and Unisys A and V series.)

ReserveLink evaluates the typical transaction volume of each customer. This minimum threshold balance is then maintained in the transaction account to pay checks as they are presented. Any excess funds above that threshold balance are periodically swept into another account. At First National, this is an MMDA — interest-bearing at the same rate as NOWs earn, in the case of NOWS, and non-interest-bearing in the case of straight checking accounts. Funds are swept back into the transaction account (and thus coming back under reserve requirements) as the threshold balance is depleted. ReserveLink uses internal algorithms to speed up or slow down the rate of the transfers of funds.

Legally, customers must be notified that the duplicate accounts are being set up, according to Moen, and regulators expect to receive courtesy notification that the bank is adopting this strategy. First National's customers hardly commented, according to Heiser, with no more than a "dozen customers asking, out of 15,000 checking accounts." Customers don't see the sweep transactions on their statements, as the sweeps take place solely within the bank and don't involve any outside parties.

If for some reason more transactions must be passed through the companion account than MMDA rules permit, then the bank must count those balances as a reservable transaction account for the entire reporting period.

Payoff comes quickly
The bank brought the new system up in mid-March 2001. After an initial period devoted to tracking customers' usage patterns for the affected accounts, the changeover to sweeping commenced.

Heiser says the biggest burdens are on the front end, during setup of the new system. "After that, there isn't a lot of work," he explains. Moen notes that after the initial purchase price of the software, the only direct cost of the program is a modest annual fee for maintenance. (The bank was able to obtain the software for $20,000.)

"It almost sounded like it was too good a deal" when the bank first explored the idea at the suggestion of a banking consultant, says Heiser. But since this approach proved itself, he's been mentioning it at community banker meetings he's been attending.