Local banks are facing a new era of uncertainty and possible consolidation, the unintended by-product of the U.S. Federal Reserve unwinding a $3.5 trillion money-printing experiment from the Great Recession.
At issue is whether bank deposits—the money those institutions use to make loans—will be curtailed as the Fed effectively drains dollars out of the economy that it injected via a massive bond-purchasing program it ran between 2008 and 2014.
In keeping with national trends, deposits at banks based in Dallas-Fort Worth rose 89 percent between the third quarters of 2008 and 2017, according to data that Samco Capital Markets compiled from S&P Global Market Intelligence/SNL Financial.
And cash—a primary buttress against calamity—made up a median 11.43 percent of assets at DFW-based banks last September, Samco’s numbers from S&P/SNL show. That’s up from just 3.8 percent in the same period nine years earlier.
Banks are flush with cash and deposits partly as side effects of the Fed’s purchase of $3.5 trillion worth of bonds, primarily from government agencies or in bundles of home loans, according to the American Enterprise Institute.
The Fed launched its first-ever try at “quantitative easing,” or “QE” for short, because cutting interest rates to zero in ’08 did nothing to stimulate the crash-damaged U.S. economy. The Fed paid for the bonds by doing the electronic version of printing money. The goal: Promoting lending and investment by pumping extra dollars into the system.
But since investors stashed the proceeds from those bond sales into bank accounts, QE also unintentionally created $2.5 trillion in “excess” deposits, according to a 2017 report from JPMorgan Chase & Co.
Starting late last year, the Fed began allowing $10 billion worth of bonds to expire monthly to whittle down what was once its $4.5 trillion stockpile. That means the Fed now takes in payments on debt instruments but does not reinvest the dough back into the economy, effectively taking the money out of circulation.
Last year, Chase’s investment bankers warned their regional bank clients—especially mid-sized institutions with at most $50 billion in assets—that QE’s wind-down could slash deposits by $1.5 trillion by 2021 or sooner, Bloomberg reported. Their message to the banks: Sell or merge now, before lower deposits reduce the prices banks might fetch later.
Executives of Chase, who didn’t respond to a request for comment for this article, expressed similar concerns about a deposit drain in the banking system during a July 2017 earnings call. The New York-based bank controlled 22 percent of deposits in Dallas-Fort Worth as of last June, second only to Bank of America’s 29.2 percent, according to a Samco analysis of data from the Federal Deposit Insurance Corp. Willis Towers Watson, a large insurance consultancy, echoed Chase’s concerns about deposits last year.
As Bloomberg has noted, the trickle of deposit-related acquisitions thus far—Pinnacle Financial snapped up North Carolina’s BNC Bancorp; the Canadian Imperial Bank of Commerce bought Chicago’s PrivateBancorp—have involved firms with large concentrations of “brokered deposits.”
But the end of QE also could impact the largest U.S. banks which, under a post-crisis international regulation called Basel III, must already set aside more money as a financial cushion against losses. That’s according to C. Keith Cargill, president and chief executive officer of Dallas-based Texas Capital Bancshares Inc., the holding company for $24 billion (assets) Texas Capital Bank.
“Regional and smaller banks will be faced with increased competition from across the banking sector as a whole,” Cargill says. “The unprecedented nature of this experiment in monetary policy makes it impossible to say with certainty how the unwind will impact the broad economy.”
The trouble with predicting the impact of QE’s end is there’s little precedent. The first large-scale instance of QE’s implementation came in 2001, when the Bank of Japan used the tactic to try to calm financial turbulence in that country.
When the Great Recession hit, numerous central banks besides the Fed launched their own versions of QE, including those in England, Switzerland, and the European Union. Now, the question is: What happens as the Fed becomes the first central bank to unwind its QE pile of bonds, whose value peaked at 23.5 percent of the U.S. economy?
Assuming global markets remain smooth, 2019 could bring the start of an unwinding in Japan (where QE accounted for 88 percent of that country’s economy in December 2016) and England (24 percent), experts say.
While a Fed spokesman didn’t respond to requests for comment, some experts downplay any effect unwinding might have. “I anticipate very little impact on bank deposits,” says Harvey Rosenblum, professor of business and financial economics at the Cox School of Business at Dallas’ Southern Methodist University.
A former director of research at the Dallas Fed, Rosenblum concedes that for banks to maintain cash-based financial backstops that regulations require, they may have to pay more for “core deposits.”
Core deposits come from customers in banks’ primary demographic markets. “If banks need additional deposits to fund loan and asset growth, they will pay higher interest rates to attract deposits, a process that has already begun,” Rosenblum says.
But at least for some banks, growing competition for deposits—no matter the cause—could prove to be the rub.
Battles began emerging among banks last fall for wealthy and corporate depositors, who are benefiting from short-term interest rates that, while still in the 2 percent range, are at least above zero, where the Fed kept them for most of the past decade.
Big depositors are particularly valuable for mid-sized banks that are looking to grow to the next level. However, the huge money center banks tend to win the fights for those clients, because they can pay more in interest and other perks.
On another front, the end of QE could hurt banks that have a large number of toxic assets that they can’t easily convert into cash without a big loss in value, according to Grace Wang, associate professor at Texas A&M University Galveston. Also at risk, she says: banks that rely heavily on other banks to function normally.
As it stands, some banks have lost deposits when customers found more attractive investments elsewhere. Jacob Thompson, Dallas-based managing director at Samco Capital, says he’s heard about unexpected runoffs in deposits at a handful of community banks with less than $2 billion in assets.
Those were instances of customers shifting money into investments in, say, real estate or stock markets, Thompson says. “For a period of time, there wasn’t a lot of yield available,” he adds. “Without many investment alternatives available, cash may have settled into [North Texas] banks and stayed there.”
DFW bankers are taking steps to prepare themselves for deposit shortfalls, no matter what causes them. Grand Bank of Texas, for example, has hedged against deposit risk by staggering its offerings of savings products by both interest rates and maturity dates.
The broad scope of savings products helps the $320 million-asset institution prevent sharp, immediate changes in its deposits, according to Michael Casey, its chairman and CEO. “We will be proactive in protecting our customer base,” says Casey, whose Dallas-based bank has 72 employees and four locations. “We want to ensure there is no abrupt change that would damage the quality of those deposits in any way.”
In Terrell, American National Bank of Texas has prepared several products it could introduce if it begins seeing a reduction in “liquidity,” or assets that can quickly be converted to cash to meet obligations.
“Some banks have seen a tightening of liquidity,” says Robert Hulsey, president and CEO of American National, a $2.8 billion institution that was founded in 1875. “We have not had that issue, as our current liquidity is more than substantial.”
But Hulsey, like Texas Capital’s Cargill, believes the economic vitality of North Texas will help his bank combat any negatives from the end of QE.
Cargill frames the question using a term for adding profit to a business. “Our local economy is very strong,” he says. “We believe the fundamental business advantages of Dallas-Fort Worth will continue to be accretive throughout the QE unwind.”
Jeff Bounds is a freelance business writer in Garland.