The Economy

Liquidity Floods U.S. Banks

Bank CFOs are cautious about investing the large stores of cash that businesses are depositing.
Vincent RyanNovember 10, 2011

It’s a problem many banks in Europe might love to have: an excess of U.S. dollar deposits that is bursting the seams of financial institutions’ balance sheets.

The three-year cumulative average growth rate (CAGR) of deposits at U.S. banks of all sizes is off the charts, according to data from SNL Financial. As of late October, the CAGR at BNY Mellon was 45%; at Wells Fargo, 40%; and at Fifth Third Bancorp, 33%. At many smaller banks and thrifts, the CAGR is easily in excess of 100%.

Businesses are storing lots of cash in demand deposit accounts. In part it’s because there are few options for higher short-term yields. The backing of the Federal Deposit Insurance Corp. is also comforting, and earnings credit rates (ECRs) — which offset business banking fees — are higher than what some money-market funds pay. Companies aren’t even electing to use “sweeps” anymore, since the extra yield is minimal.

The liquidity is great news for banks. Or is it?

Bank CFOs aren’t complaining, but they do note that figuring out how to invest the large sums is a challenge, given tighter underwriting and still-tepid loan demand. “Banks like us that are creditworthy are seeing folks pull money out of the markets and park [it] in deposits,” says Steve Boyle, CFO of TD Bank, which had $142 billion in deposits as of late October. “But if we’re not sure those deposits are going to stick around, we can’t really invest them long term or lend them.”

TD Bank combs through each class of deposit and assesses how permanent those deposits are, Boyle says. If $800 million comes in from a hedge fund, “we’ve got a pretty good idea that that money isn’t going to stick around for six years,” he says. “Essentially we have to hold liquidity against the whole deposit.”

That short-term money makes it hard for banks to earn a decent spread, particularly with the higher cost of FDIC insurance, Boyle says. TD Bank has a low loan-to-deposit ratio, so it is buying lenders, such as Chrysler Financial and MBNA Canada, that will give it more asset-generation capabilities.

At Bank of Marin in Novato, California, total deposits rose from $810 million in 2008 to $1 billion at the end of 2010. “There are not a lot of good options for investment,” says Christina Cook, Bank of Marin’s finance chief. “It keeps us on our toes, because we always have to look at the best way to use liquidity.” One solution is to pay off debt. In the third quarter, the bank repaid a $20 million fixed-rate advance from a Federal Home Loan Bank, despite incurring a prepayment penalty.

The plethora of deposits has treasury-management executives of banks asking CFOs of nonfinancial corporates the same question banks have to ask themselves: what are the plans for all this cash?

“We want to understand a company’s trigger points,” says Jim Graves, a senior vice president in global treasury management at Cleveland-based KeyBank. “What are the conditions and events that will make them use their cash?”

Graves says that the deeper and richer that discussion with a client, the more he can negotiate rates, whether explicit interest or an ECR. “I can give you 15 to 20 basis points overnight, but if you’re going to [keep the money here] six to nine months and [the balance] is going to be relatively stable, that’s a different situation,” he says.

Stability is important: bankers don’t like surprises. Graves says one client deposited $40 million at a negotiated rate, but then turned around the next day and brought in another $100 million. “I couldn’t pay them the agreed-to rate on the $40 million,” he says.

The silver lining for banks and their clients? The large stockpile of liquidity could provide some cushion if another market funding crisis arises.

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