In Cash Glut, Banks Try to Discourage New Deposits

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With attractive lending opportunities hard to come by, bankers are finding themselves doing what would have been unthinkable just two years ago: discouraging deposits.

Most large and regional banking companies are drowning in deposits, raising concern that excess liquidity could be a drag on earnings in coming quarters.

Though interest rates on deposit accounts are manageable, due in part to historically low rates, costs remain associated with handling those relationships. Banks have also seen their ability to charge certain fees, on overdrafts, for example, constrained by the recent wave of financial reforms.

"The bottom line is that it hurts your margin if you get a lot of deposits and have nowhere to put them," said Kevin Fitzsimmons, an analyst at Sandler O'Neill & Partners LLP. "The margin is the one thing banks are used to controlling, so it requires behavior modification to tone down an appetite for deposits."

Two years ago, gathering deposits was a priority as liquidity concerns contributed to the demise of big financial institutions like Washington Mutual Inc. At that time, the median loan-to-deposit ratio for the largest banking companies was above 105%, showing an imbalance where loans exceeded deposit levels, according to regulatory filings. By mid-2010, the median for the 15-biggest banking companies was 94.1%, as the pendulum has swung to deposit-heavy balance sheets.

"Consumers are reluctant to lock up their money and prefer to have cash readily available even if it means lower interest rates," said Dan Geller, an executive vice president at Market Rates Insight, a research firm that has been keeping close tabs on deposit levels. "Fear of inflation, combined with uncertainty about the prospects of meaningful economic recovery, is causing some consumers to sit on their cash."

Early this year, a large inflow of deposits benefited banks despite limited opportunities to turn around and lend the money. Instead, bankers could let higher-rate brokered certificates of deposits mature, replacing them with the lower-cost "core" deposits. They were also investing some excess funds in securities, but regulators this year warned against such a strategy due to the interest rate risk associated with hefty portfolios.

Now the primary options left for banks involve turning depositors away or housing deposits at the Federal Reserve.

In April, James Rohr, the chairman and CEO of PNC Financial Services Group Inc., said that deposits held at the Fed were "almost a nonperforming asset," given the negligible 0.08% PNC was getting for the holding. Though PNC has reduced such exposure, other executives expressed similar concern during recent quarterly conference calls.

"Excess liquidity has not dissipated as quickly as we had expected," said Beth Acton, the chief financial officer at Comerica Inc., during the Dallas company's conference call with analysts last week. Comerica had, on average, $3.7 billion parked with the Fed in the second quarter, which cost the company roughly 23 basis points on its net interest margin, she said.

"We expect that excess liquidity will remain at these levels for the rest of the year," she added.

Retail customers are not the only ones hoarding cash, as some bankers discussed how loan and deposit levels for commercial clients are also out of whack.

James Dimon, the chairman and CEO at JPMorgan Chase & Co., gave insight into such an issue with the New York company's middle-market clients. In early 2009, these clients had virtually even levels of loans and deposits, at $100 billion on each side of the balance sheet. "Now we have $90 billion of loans and $130 billion of deposits for those clients," he said during the company's July 15 call.

"You could see that start to show. They're pretty flush" with cash and have "huge unused lines" of credit, he said.

Donald Mullineaux, a finance professor at the University of Kentucky, said the issue is putting even the savviest bankers in a tough position. "The only way to get a higher yield is to take on more risk, and bankers are saying they aren't willing to do that yet," he said. "So if you are shrinking the asset side of the balance sheet, you have to reduce rates to shrink deposits."

BB&T Corp. is among those doing just that, which is ironic given the bank's 2006 finding that 75% of its economic profit came from deposit-gathering. The bank made numerous internal adjustments to focus more on deposits and had maintained a policy with commercial borrowers that it would not make a loan unless the applicant agreed to bring over a deposit relationship.

It has since changed its strategy. The Winston-Salem, N.C., company attributed a portion of its margin expansion, which rose 24 basis points from the first quarter, to reduced deposit levels.

Other banks have failed to keep depositors away. "I've had a couple of CEOs tell me that they were deliberately trying not to grow them and they're coming in anyway," Fitzsimmons said.

Observers said a key part of deposit accounts' profits had come from associated fees, which are under pressure from recent legislative and regulatory changes. A major headwind blew in when banks were required to let customers opt out of overdraft charges. The Dodd-Frank Act, which was signed into law last week, also requires the Fed to set debit interchange fees that are proportional to the cost of processing the transactions.

Geller of Market Rates Insight and others said that, in the long term, deposits are likely to regain value, especially as lending opportunities resurface. The upside is the deposit mix — lower-rate money market account balances rose 11.6% during the first half of 2010, compared to "negligible" increases in mid- to long-term CD balances that are more expensive for banks. Over time, banks "can make up some of the revenue loss from fees," he said.

Mullineaux, however, warned that the greater risk for banks is not margin compression but rather lost potential revenue tied to deposit relationships that might get turned away. "You wonder if they can get those customers back when they want them back," he said.

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