RBC's Cloherty on Deposit Runoff
RBC Capital Markets' Mike Cloherty writes on "Deposit runoff and the rate outlook." He explains, "We look at one conceivable disruption to the rally: Fed balance sheet unwind will cause banks to shorten the expected life of their deposits, forcing them to shorten their asset mix. While the timing of this model change remains uncertain, we might see enough of a portfolio adjustment this summer to turn the rally on its head. The core issue is not a funding shortfall -- the deposit outflow due to Fed balance sheet unwind is likely to be just over $500bn in 2018 out of an $11.7T deposit base. Normal growth would push deposits up $850bn increase in 2018 -- that suggests a $350bn increase in deposits in 2018 as the Fed portfolio shrinks. But there will be dramatic effects on deposit modeling. In today's heavily regulated world, changes in models can have significant real world impacts." Cloherty continues, "We are not suggesting these shifts will cause massive 2003-style bank sales.... The huge question is timing. Will banks anticipate a regime change and alter their deposit modeling in advance of the Fed runoff? Or is the world so F9 driven that we will have to wait to see the empirical results of more rapid deposit turnover before deposit models change? `QE created bank deposits and the balance sheet unwind will eliminate deposits. Unfortunately, the distribution of the deposit loss across the system will be wildly uneven and hard to predict. The big issue is how modeling of deposits changes. Banks adjust their asset-liability mix to ensure that they are not excessively relying on short funding of long assets. In recent years, massive deposit creation from QE, soft loan demand, zero rates, and MMF reform depressed deposit competition. Any deposit modeled on data from recent years will show an extremely long average life. That long liability allows banks to own higher yielding, longer maturity assets without showing a worrisome funding gap. A significant shortening of the expected life of a deposit would create an asset/liability gap, putting pressure on banks to shorten their assets."
