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Analysis: U.S. banks get ready for the day when deposits shrink

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst
The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Peter Rudegeair and Carrick Mollenkamp

NEW YORK (Reuters) - U.S. banks, with nudging from regulators, are planning for the day when the economy recovers, rates rise, and depositors yank money from safe but low-paying accounts.

Those withdrawals could be fast and painful for banks, which will have to pay depositors with either cash on hand, money borrowed from elsewhere, or in a worst case scenario the proceeds of asset sales.

Banks are preparing through steps including borrowing in bond markets and from Federal Home Loan Banks. But getting ready for rising rates has not been easy because there is little historical precedent for the current environment, where interest rates are essentially zero and borrowers can move money out of banks with a few clicks.

"What happens to deposits when rates rise is a big unknown," said Kerri Corn, director for market risk at the Office of the Comptroller of the Currency, the Washington, D.C. regulator. "That's a main worry for us." The OCC has been pressing banks to prepare for rising rates across their businesses since 2010.

Banks have high levels of deposits to think about now. Since the financial crisis, low short-term rates have left individuals and companies with few low-risk options for cash, other than pouring it into banks. Deposits surged 40 percent from September 2008 through the middle of the last month, to $9.57 trillion, according to Federal Reserve data.

But short-term rates will not stay low forever, which became painfully apparent to banks this summer when longer-term rates spiked.

Some banks say they are getting ready for that possibility now, to minimize later damage. Recently, Fifth Third Bancorp finance chief Daniel Poston told investors at a conference that the Cincinnati, Ohio, bank was planning to issue bonds or similar instruments to build another source of funding to cope with an anticipated loss of deposits.

Other banks are also seeking different forms of funding. Commercial banks' loans from Federal Home Loan Banks rose by $40 billion in the second quarter, the fastest pace of growth since 2007, according to analysts at Portales Partners.

Even when rates start rising and cash starts moving elsewhere, U.S. banks can afford to lose 23 percent of their deposits and still have enough money to fund their loans, based on historical ratios, Fitch analysts said in an August report that analyzed bank deposit flows.

NOT AN IMMEDIATE THREAT

Deposit outflow is not an immediate threat to balance sheets at most banks. The Federal Reserve said last month it will not start winding down its bond-buying stimulus program, let alone raise short-term rates, until the U.S. economy shows more evidence of having improved. With the federal government partly shut down, robust economic growth seems further off.

For now, corporate depositors have little incentive to switch into money market funds. A corporation can earn about 0.09 percentage points of interest on bank deposits, more than the 0.02 to 0.04 percentage points paid by a government debt money market fund and about even with the 0.08 to 0.12 percentage points on a riskier prime money market fund, according to Tom Hunt, director of treasury services at the Association for Financial Professionals.

In other words, bank deposits pay many customers the same as or more than a money market investment. That may be why money-market fund assets declined from a peak $3.85 trillion in January 2009 to $2.67 trillion in September 2013, according to iMoneyNet, a money-market data provider.

Meanwhile, deposits have surged.

"Banks were fighting each other for deposits in 2004, 2005, and 2006, but since then, deposits have become easy. I've had bankers tell me, 'I can't turn the deposit faucet off,'" said Scott Hildenbrand, a strategist at investment bank Sandler O'Neill who advises banks on their assets and liabilities.

Some banks have tried to turn down the faucet. In August 2011, during a U.S. debt ceiling crisis, Bank of New York Mellon Corp announced a plan to charge some corporate and fund management clients a fee for adding too much to their deposits, although it never acted on that threat. It thought about making a similar move last year amid euro zone turmoil.

Banks can pay higher rates to depositors because they have the freedom to invest customers' funds into longer-dated and higher-yielding instruments compared with money-market funds, said Dave Robertson, head of the financial services practice at Treasury Strategies, Inc, a consulting firm.

Short-term rates are still near zero, but rising longer-term rates have already shown signs of hurting bank profit. Wells Fargo & Co said last month it expects to make nearly 30 percent fewer home loans in the third quarter than it did in the second quarter. [ID:nL2N0H50U5] Wells, JPMorgan Chase & Co Bank of America Corp and Citigroup Inc have announced thousands of mortgage layoffs in recent weeks.

On the deposit side, UMB Financial Corp, a Kansas City, Missouri bank with $15.3 billion in assets, has already experienced a painful loss of business. The lender said in a securities filing that one customer plans to move $1.08 billion of deposits to another bank in the coming months. As of June 30, that represented 7.42 percent of UMB's total deposits. The bank, which celebrated its 100-year anniversary this year, said that losing the customer could cost it 4 cents to 9 cents in per-share earnings in 2014. The bank earned $3.07 per share in 2012.

(Reporting by Peter Rudegeair and Carrick Mollenkamp; Editing by Dan Wilchins and David Gregorio)

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