Promontory Interfinancial Network, which produces the FDIC sweep service Insured Network Deposits (IND) and Certificate of Deposit Account Registry Service (CDARS), recently published its "2017 Funding & Deposits Report," which discusses bank funding and deposits and which contains a section on money fund reforms. Promontory President and CEO Mark Jacobsen explains, "Over the last two years, we have reached out to Promontory Network members and asked them to share their opinions and insights.... The response has been heartening as almost 1,000 bank CEOs, presidents, and CFOs have participated in our quarterly Bank Executive Business Outlook Survey.... With that, I am pleased to announce the launch of an annual Funding & Deposits Report, a new outgrowth of the Bank Executive Business Outlook Survey."
The Executive Summary says, "The marketplace for deposits remained relatively stable throughout 2016. The small increase in the federal funds rate at the end of 2015 did raise the cost of funding, but, overall, funding costs stayed at historically low rates and most banks -- money center institutions, large regional banks, and community banks -- remained fairly flush with deposits.... Sixty-nine percent of respondents reported that they expect to experience a moderate increase in funding costs within the next 12 months.... In particular, larger community banks are aggressively pursuing corporate deposits."
It discusses "Money Market Mutual Fund Reform," saying, "Most community banks reported seeing little impact on deposit availability from the change in money market mutual fund (MMMF) rules. Larger community banks were more likely to report that the MMMF rule change has increased deposit availability. These larger community banks were also more optimistic that MMMF reform would increase availability of deposits in the future."
On "Composition and Accessibility of Bank Funding," the report says, "For most community banks, retail deposits are the primary source of bank funding. On average, Q4 2016 survey respondents indicated that they prefer funding from retail depositors to make up the majority (53%) of total bank funding, corporate deposits to make up 29% of bank funding, deposits from public funds to make up 11%, and wholesale funding to make up the final 8% of bank funding."
A section on "Money Market Mutual Fund Reform," comments, "The October 2016 enactment of the new SEC rules governing money market mutual funds (MMMFs) has transformed the money fund industry. The change has led to a dramatic shift in fund placements from prime funds to government funds. Data from Crane Data's Money Fund Intelligence shows that, between October 2015 and October 2016, more than $1 trillion moved from prime funds to government funds. At some point, investors may get hungry for more yield and consider a return to prime funds or a move elsewhere. In the latest Bank Executive Business Outlook Survey, bankers indicated that, so far, little impact has been felt from the change in money market fund rules when it comes to increasing deposit availability."
It continues, "Larger community banks with between $1 billion and $10 billion in assets were more likely to report that the MMMF rule change has impacted deposit availability.... Larger community banks were much more likely to see the rule change as eventually making deposits more available for their institutions.... The increased availability of corporate deposits that were once kept in money market funds could make a substantial difference for banks, particularly larger community banks, which have indicated that they are eager to add corporate deposits to their funding mix. Of the various depositor types (retail, corporate, public funds), corporate deposits are perceived to be the least accessible by community banks."
Promontory's report also includes, "A Conversation with Peter Crane on the Impact of MMMF Change" The Q&A says: "Q. How has the MMMF rule change affected the total assets in money market funds and the yields of these funds? A. Prime assets declined by seventy-five percent; $1.1 trillion moved. Everyone and their brother sold prime and moved to government. The move has essentially inverted the prior asset allocations of those fund categories."
Crane continues, "For now, the yield spreads between prime funds and government funds are tighter than usual because you actually had two big factors going on at the same time. Normally, as money left prime and went into government, one would have expected the spreads to grow. But the prime funds were restricted ahead of the October 14 date when the rule went into effect. The prime funds were getting as short as possible to prepare for redemptions, which led to lower yields. Going forward, the yield spreads between prime and government funds are expected to return to historical levels, which has generally been about 25 bps."
The Q&A also asks, "Q. Have government funds been offering better yields to attract the cash moving from prime funds and are those yields going to continue moving forward? A. Certainly, some funds have cut their expense ratios to make their government funds more attractive and to catch a bigger share of the assets flooding into the government segment -- JP Morgan being the biggest example of that. Whether that's temporary or not is a different question. It could be more permanent, because government money funds have just gotten an enormous boost to their economies of scale. In general, a $60 billion fund doesn't have to charge as much as a $4 billion fund. On the other hand, you still have remnants of fee waivers where a lot of funds, more retail-ish funds in particular, are still only charging a part of their fees because of the ultra-low rate environment. So as the Federal Reserve raises rates, you're going to see the second leg of this fee unwinding."
It adds, "Q. Are investors going to stay in government funds or will they move back to prime funds or move out to other investment options? A. That's the trillion dollar question. But nobody knows. For now, clearly, the bulk of the assets have shown a preference for government money funds. But as yields change, if spreads grow, there's a possibility some investors will move back. Everyone is still re-pricing what the costs of safety are and what kind of yield and premiums they're going to need. Even though a gate going up on a money fund is an extremely low-probability, disaster-only scenario, people just can't afford to lock up their cash. Nobody wants their transaction pipeline getting clogged up or broken because so many other pieces of so many businesses are dependent on those transactions flowing smoothly."
Crane explains, "Surveys have said investors will need 40-50 bps to consider a move back to prime, and we're barely at half of that now. Spreads are going to have to go up to get people to consider such a move. Even at those levels, it's unclear whether or not investors are going to move back. In the meantime, investors have been looking at alternatives and other options that give them the safety, liquidity, and yield that prime funds used to give them. But they either haven't found that solution yet, or the path of least resistance was to switch, then prepare to find other options."
Finally, Promontory asks, "Q. What kind of impact might this have on the availability of institutional deposits for banks? A. So far, the move into government funds has appeared to be almost entirely a one-to-one move. Very little money appears to have left money funds altogether. Over time, though, I would assume that bank deposits will increase. Bank deposits have grown since the financial crisis and have shown no sign of abating. You look at the Fed's H6 Money Stock Measures data and it has been a straight line up since 2008. 16 going on 20 years brokerages have moved money back from money market mutual funds -- their default sweep vehicle -- into bank deposit products. The zero yield environment and the MMMF regulatory changes have only accelerated that trend. People tend to look at the world as a zero-sum game, but money is being created and destroyed and added and removed everywhere. So even though it looks like a one-to-one swap, the new money clearly is being redirected in other places."
