It’s Not You, It’s Me: Finding Investment Alternatives for ... GS2 Finding... · Finding...
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It’s Not You, It’s Me: Finding Investment Alternatives for Bank Deposit Investors
Garret Sloan, CFA
Director, Fixed Income Market Strategy
Vanessa Hubbard
Associate, Fixed Income Market Strategy
Bank Deposits Growing in Corporate Portfolios
2
Growing Deposit Allocations in Corporate Portfolios
Bank deposits have grown on an outright basis and in terms of
proportional share of institutional cash investments
since the financial crisis of 2008 in which a number of global
banks failed. 0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2009 2010 2011 2012 2013 2014
Other
Variable rate demand notes
Auction rate securities
Municipal notes
Asset-backed securities
Enhanced cash funds
Separately managed accounts
Eurodollar deposits
Repurchase agreements
Agency securities
Commercial paper
Treasury bills
Diversified MMMFs
Treasury-only MMMFs
Bank Deposits
Source: Wells Fargo Securities, LLC, AFP
3
Deposit growth can be attributed to four primary drivers:
Bank Deposits
Source: Wells Fargo Securities, LLC
Potential Reasons Behind Deposit Growth
• Lack of business reinvestment has resulted in cash accumulation
• Unlimited FDIC insurance encouraged companies to park cash1
• Attractive ECR relative to money market rates
• Government support (TARP) and regulatory reform has reduced perceived bank risk
1 Unlimited FDIC deposit insurance ended December 31, 2012
Liquidity Coverage Ratio (LCR)
4
Liquidity Coverage Ratio
According to the rule set forth by the Federal Reserve, a bank’s LCR must be greater than 100
percent at ALL times or the bank becomes subject to
regulatory restriction.
The LCR rule has been finalized by the Federal Reserve
The rule requires U.S .bank holding companies with more than $250 billion in consolidated assets, or more than $10 billion in on-balance sheet foreign exposure, to hold enough High Quality Liquid Assets (HQLA) to withstand severe deposit outflows over a 30-day period
A modified version for bank’s with assets below the above thresholds have also been introduced
Liquidity Coverage Ratio 100% <
Total HQLA
Net Cash Outflows over Stress Horizon
Liquidity Coverage Ratio Equation
Banks are now more likely to (all else equal):
Purchase assets that provide the best funding efficiency under the LCR and,
Reduce yields on certain deposit products to compensate for the increased cost of institutional demand deposit offerings.
Banks (as investors) may become more competitive in buying high quality assets, but banks (as deposit takers) may become less competitive when compared to similar money market investment products.
Source: Wells Fargo Securities, LLC, U.S. Federal Register
Liquidity Coverage Ratio (LCR)
5
An analysis of expected deposit outflows is required, based on a deposit’s purpose and depositor type
Deposits are first distinguished as either retail or wholesale
If a deposit is classified as wholesale, it is further broken down as either operational or non-operational
Numerator: High Quality Liquid Assets (HQLA)
Denominator: Deposit Outflows
HQLA’s are separated into two categories, Level 1 and Level 2 with haircuts assigned to each category based on the perceived liquidity characteristics of the securities
Level 1 Assets – 0 percent haircut
Level 2 Assets – 15 to 50 percent haircut
Source: Wells Fargo Securities, LLC, U.S. Federal Register
6
LCR – HQLA Breakdown
A more detailed breakdown of the haircuts assigned to securities under the LCR rules, is listed in the table below:
Level 2 assets are further broken down by either a 2A or 2B category. The haircuts ranging from 15 percent to 50 percent can be interpreted that only 85 percent to 50 percent of the security’s value may be used for purposes of calculating the security’s contribution to HQLA.
The purpose of the haircuts is to direct banks to use longer-term sources of funding or equity capital to finance less liquid assets.
We expect banks may be more likely to bid up the value of Level 1 assets versus Level 2 assets subject to HQLA haircuts in order to minimize the impact of haircuts on bank balance sheets
Liquidity Coverage Ratio (LCR) - HQLA
HQLA Description Haircut % HQLA
Level 1 (1) Federal Reserve Balances; (2) foreign reserves; (3) Treasury securities; (4) sovereign debt
0% Min. 60%
Level 2A Certain securities issued or fully guaranteed by U.S. GSEs 15% Max. 40%
Level 2B (1) Liquid investment-grade non-financial corporate bonds; (2) Certain exchange- traded non-financial equities
50% Max. 15%
Source: Wells Fargo Securities, LLC, U.S. Federal Register
U.S. Bank Investment Portfolio Allocations
7
Banks, especially those with >$250B in assets, have been increasing their holdings of U.S. Treasuries in their investment portfolios due to LCR requirements.
Source: BLS , Boston Federal Reserve Bank and Wells Fargo Securities, LLC
U.S. Bank Holdings of U.S. Treasuries U.S. Treasuries as a % of Total Portfolio
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
Q4 2013 Q4 2014
U.S
. Tre
asury
Hold
ings (
$M
M)
Total Industry >250B in Assets
$211,0
03
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Q4 2013 Q4 2014
Tre
asuries a
s a
% o
f Tota
l
Total Industry >250B in Assets
10.7
%
6.2
%
$188,5
36
8
LCR – Deposit Outflows
Focusing on wholesale deposits, operational deposits can be characterized as those deposits that:
Reflect a deep relationship with the customer
Are linked to bank services like payments or payrolls, and
Are considered stable
An operational deposit must be linked to an operational service and can be defined as “necessary for the provision of operational services”
The twelve services listed in the table below may qualify a deposit for operational treatment
Liquidity Coverage Ratio (LCR) – Deposit Outflows
Source: Wells Fargo Securities, LLC, U.S. Federal Register
LCR- Defined Operational Services that may be Linked to an Operational Deposit
Payment remittance Payroll administration Transmission, reconciliation and confirmation of payment orders
Daylight overdraft Determination of intra-day and final settlement positions
Settlement of securities transactions
Transfer of recurring contractual payments Client subscriptions and redemptions Scheduled distribution of client funds
Escrow, funds transfer, stock transfer, and agency services, etc.
Collection and aggregation of funds Capital distributions
9
LCR – Deposit Outflows
In addition to the operational services listed on the preceding slide, additional criteria are required to meet the operational deposit definition as listed in the table below:
The table above highlights that a bank may not use economic incentives to maintain excess funds if it classifies the deposit as operational.
Economic incentives are highlighted in the table above because of its importance to investors that use above-market deposit rates to maintain excess balances.
Liquidity Coverage Ratio (LCR) – Deposit Outflows
Source: Wells Fargo Securities, LLC, U.S. Federal Register
Additional Criteria for Operational Deposits
Services held pursuant to an agreement subject to high termination or switching costs
Deposits must be held in an operational account
Account must be for the primary purpose of obtaining operational services
Prohibition of economic incentives to maintain excess funds
Banks must separate “operating” from “excess” deposit balances, taking into account average balance volatility
Exclusion of prime brokerage services-related deposits
Exclusion of “excess” deposits from banking organizations
10
LCR – Deposit Outflows
The table below illustrates the outflow assumptions for various wholesale depositor categories:
Liquidity Coverage Ratio (LCR) – Deposit Outflows
Source: Wells Fargo Securities, LLC, U.S. Federal Register
Wholesale Depositor Operational Non-Operational
Insured Uninsured Insured Uninsured
Non-Financial Corporate 5% 25% 20% 40%
Mortgage Escrow N/A 25% N/A N/A
Public Entity 5% 25% 20% 40%
U.S. GSEs 5% 25% 20% 40%
Sovereigns 5% 25% 20% 40%
Multilaterals 5% 25% 20% 40%
Non-Bank Regulated Financial 5% 25% N/A 100%
Pension Fund 5% 25% N/A 100%
Investment Advisor N/A N/A N/A 100%
Investment Company N/A N/A N/A 100%
Non-Regulated Fund (Hedge, PE) N/A N/A N/A 100%
Other Legal Entity 5% 25% N/A 100%
Bank 5% 25% N/A 100%
Special Purpose Entity 5% 25% N/A 100%
11
LCR – Deposit Outflows
The table below illustrates that more than 40 percent of corporate investors use ECR/deposit rates as a major determinant in choosing a bank deposit provider.
Investors may also have a higher propensity to look at non-bank investment alternatives if the yield differential between bank deposits and short-term investments is sufficiently wide.
Non-Financial Corporate
Liquidity Coverage Ratio (LCR) – Deposit Outflows
Source: Wells Fargo Securities, LLC, AFP Liquidity Survey
Major Determinants for Which Banks to Use When Investing in Bank Deposits
All Respondents Net Investors
Overall bank relationship 72% 71%
Credit quality 65% 69%
Earnings credit rates 41% 41%
Compelling rates on offered deposits 36% 41%
Simplicity of working with bank 36% 36%
Ability to determine how to apply ECR 10% 10%
Basel III considerations 6% 6%
Other 3% 4%
12
Dollar Amount of HQLA
The table below illustrates the dollar amount of HQLA that a bank may be required to hold for certain deposit types.
Banks will be under pressure to reduce the costs associated with the various deposit categories. It may be the case that banks will be interested in divesting out of certain deposit types and others will be re-priced significantly
Non-Financial Corporate
Bank Deposits
Source: Wells Fargo Securities, LLC
Estimated HQLA for $50 Million Sample Deposit
HQLA Category Financial Non-Operational
Financial Operational
Non-Financial Non-Operational
Non-Financial Operational
30-Day Outflow Assumption $50,000,000 $12,500,000 $20,000,000 $12,500,000
Level 1 $50,000,000 $12,500,000 $20,000,000 $12,500,000
Level 2A (Maximum 40%)2 $53,529,412 $13,382,353 $21,411,765 $13,382,353
Level 2B (Maximum 15%)3 $55,625,000 $13,906,250 $22,250,000 $13,906,250
2 Assumes that HQLA is 40% allocated to Level 2A assets, using a 15% haircut, with 60% invested in Level 1 3 Assumes that HQLA is 40% allocated to Level 2B assets using a 50% haircut, 25% allocated to level 2A assets, using a 15% haircut, with 60% allocated to Level 1 assets
13
Public Entity Collateralized Deposits
Collateralized public entity deposits are treated similar to uncollateralized public entity deposits for outflow assumption purposes.
Consequently, deposits that are fully collateralized by Treasuries should fare well from a pricing standpoint as the securities held for collateral purposes may also satisfy the HQLA requirement under LCR.
There are instances whereby public entity deposits may reflect those of other uncollateralized deposits and banks will be required to increase their HQLA to meet LCR requirements. The table below lists the number of U.S. state statutes that accept collateral types and their status under current LCR rules:
Non-Financial Corporate
Public Entity Collateralized Deposits
Source: Wells Fargo Securities, LLC
Collateral Type Number of States Accepting Collateral
HQLA Eligibility
Treasuries 484 Level 1
Agencies 48 Level 2A
Agency MBS 48 Level 2A
Municipal Bonds 43 Non-Eligible (possible change)
ABS/CMO 6 Non-Eligible
4 Note: Not all states require collateral to support public entity deposits
Alternatives for Short-Term Investors
14
We do not anticipate that traditional corporate cash investors will move a significant amount of cash into short-term bond funds
Expect short-term bond funds to remain a very small component of overall cash strategies
Overall fixed income supply, bank demand for government assets, deposit flows out of banks and outflows from prime funds to government funds will likely impact short-term yields going forward
The yield differential between various asset classes will likely become more pronounced, proving a more attractive investment environment for direct investments
Money Market Funds
Short-Term Bond Funds
Direct Investments
Expect money market fund balances to remain an attractive alternative in both floating-rate and fixed-rate options
Money market funds are a strong alternative for short-term operating cash balances and are a close cousin to bank deposit products
Source: Wells Fargo Securities, LLC
16
Positioning Corporate Cash Portfolios
Curve steepening in the current environment is causing investors to look at their strategic cash allocations to see if there are opportunities to extend or introduce new asset classes.
Source: ICI, Wells Fargo Securities, LLC
Segmentation of the Corporate/Public Cash Portfolio (for illustrative purposes only)
Operating Cash (Horizon - daily)
Reserve Cash (Horizon - Quarterly)
Restricted Cash (Horizon - longer-term)
Strategic Cash (Horizon - longer-term)
Liquidity,
Stability
of Principal
Less liquidity,
higher yields,
more price
volatility
Q1 Q2 Q3 Q4
Liquidity, stability of principal
Less liquidity, higher yields, more price volatility
17
Positioning Corporate Cash Portfolios
Corporate Cash Portfolio Segments have different Durations, Objectives, Strategies and Return Expectations
Operating Cash
Reserve/Core Cash Strategic Cash
Investment Horizon 0 – 6 months 6 months – 2 years 1 – 5 years
Portfolio Duration 30 - 90 Days 6 – 18 months 2 – 3 years
Cash Flow Volatility High Low/Maturity Matched Very Low/Maturity
Matched
Strategy Money Market/Cash
Equivalents Incremental Duration and
Credit Risk Incremental Duration
and Credit Risk
Benchmark N/A Treasury-based
LIBOR “+” -based Index-based
(strategy-specific)
Source: Wells Fargo Securities, LLC
18
Products can be placed in multiple buckets. However,
certain products are more suited to certain investment styles
based on relative liquidity and duration profiles.
Positioning Corporate Cash Portfolios
Source: Wells Fargo Securities, LLC
Duration
Yie
ld
Bank Deposits Sweep Accounts
Money Market Funds Treasury Bills
Discount Notes Repo
Commercial Paper Certificates of Deposit
TE/Taxable VRDNs
Operational Cash
Commercial Paper Certificates of Deposit Short Corporate Bonds Treasury Bills/Notes
Agency Discos/Bullets Agency
Municipal Securities Floaters
Certificates of Deposit Brokered CDs
Corporate Bonds Treasury Notes
Agency Callables Agency Bullets
Municipal Securities Asset-backed Securities
Reserve Cash
Restricted/Strategic Cash
S/T Investments > 12M Money Markets < 12M
Product Segmentation Across Liquidity Buckets
19
Portfolio Construction Approaches
The Basic Approach manages all expected cash outflows through
existing cash balances, represented by the grey area.
The cash balances represented by the light and dark blue areas are not anticipated to be used
and can be invested further out on the curve to augment yield.
Source: Wells Fargo Securities, LLC
$0
$5
$10
$15
$20
$25
$30
$0
$5
$10
$15
$20
$25
$30
7-Jan 7-Feb 7-Mar 7-Apr 7-May 7-Jun 7-Jul 7-Aug 7-Sep 7-Oct 7-Nov 7-Dec
$9M Short-term inv. (1-3Y)
$4M Short-term inv. (6 – 12M)
MMFs,
LGIP, O/N Inv.
Cash Balance Forecast
Basic Approach
20
Portfolio Construction Approaches
The Maturity Matching Approach identifies the size and
dates of known cash outflows and invests an equivalent
amount of cash to those dates. Liquidity is partially managed through maturity matching,
allowing short-term investments to constitute a larger part of the
overall portfolio.
Source: Wells Fargo Securities, LLC
$0
$5
$10
$15
$20
$25
$30
$0
$5
$10
$15
$20
$25
$30
Short-term inv. (1-3Y)
Short-term inv. (6-12M).
MMFs, LGIP, O/N Inv.
Cash Balance Forecast
Maturity Matching Approach
Preparing for the Changes in the Short-Term Investment Environment
21
Maximize Liquidity and Outperform LCR-Pressured Bank Deposits
We suggest investors consider three options to efficiently
allocate short-term investments into categories that maximize
liquidity and outperform LCR-pressured bank deposits
Ensure investment policy is up to date and flexible
Have a clear picture of cash flows over multiple investment horizons
Develop an investment strategy to aid in fulfilling the objectives outlined in your investment policy
Source: Wells Fargo Securities, LLC
22
Disclaimer
This publication is intended for institutional accounts only (as defined in FINRA Rule 4512), please do not forward. Strategist Commentary is a product of Wells Fargo Securities Fixed Income Sales and Trading and is not a product of Wells Fargo Securities, LLC’s Research, Economics and Strategy. The views expressed herein might differ from those of Research, Economics and Strategy. Important Information for Non-U.S. Recipients This report is prepared by Wells Fargo Securities, LLC in accordance with U.S. law and applicable rules and regulations for use by institutional investors. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. This report is not intended for, and should not be relied upon, by retail investors. Please consult your Investment Representative for additional information. U.S. residents are directed to wellsfargo.com for investment and related services. Important Information for Australian Recipients Wells Fargo Securities, LLC is exempt from the requirements to hold an Australian financial services license in respect of the financial services it provides to wholesale clients in Australia. Wells Fargo Securities LLC is a U.S. broker dealer registered with the U.S. Securities and Exchange Commission and a member of FINRA and SIPC. Wells Fargo Securities, LLC is regulated under U.S. laws which differ from Australian laws. Any offer or documentation provided to you by Wells Fargo Securities, LLC in the course of providing the financial services will be prepared in accordance with the laws of the United States and not Australian laws. Important Disclosures Relating to Conflicts of Interest and Potential Conflicts of Interest Wells Fargo Securities, LLC may sell or buy the subject securities to/from customers on a principal basis. Wells Fargo Securities, LLC has or may have proprietary positions in the securities mentioned herein. The trading desk has or may have proprietary positions in the securities mentioned herein. The author's compensation is based on, among other things, Wells Fargo Securities, LLC's overall performance, the profitability of Wells Fargo Securities, LLC's Markets Division and the profitability of the trading desk. This report is for your information only and is not an offer to sell or a solicitation of an offer to buy the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal, or the entity that provided this report to them, if they desire further information. The information in this report has been obtained or derived from sources believed by Wells Fargo Securities, LLC to be reliable, but Wells Fargo Securities, LLC does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Wells Fargo Securities, LLC at this time and are subject to change without notice. Wells Fargo Securities, LLC and its affiliates may from time to time provide advice with respect to, acquire, hold or sell a position in, the securities or instruments named or described in this report. About Wells Fargo Securities Wells Fargo Securities is the trade name for the capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including but not limited to Wells Fargo Securities, LLC, a member of NYSE, FINRA, NFA and SIPC, Wells Fargo Prime Services, LLC, a member of FINRA, NFA and SIPC, and Wells Fargo Bank, N.A. Wells Fargo Securities, LLC and Wells Fargo Prime Services, LLC are distinct entities from affiliated banks and thrifts. Copyright© 2015 Wells Fargo & Company SECURITIES: NOT FDIC:-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE