JPMorgan Chase has some advice for regional banks: A deposit drain is coming, so merge while you can.
The company's investment bankers are warning depository clients that they may begin feeling the crunch in December, thanks to a byproduct of how the U.S. Federal Reserve propped up the economy after the financial crisis, according to a copy of a confidential presentation obtained by Bloomberg News and confirmed by a JPMorgan spokesman.
JPMorgan argues that some midsize U.S. banks -- those with $50 billion in assets or less -- could face a funding problem in coming years as the Fed goes about shrinking its massive balance sheet, according to the 19-page report the New York-based bank has begun sharing with clients.
The Fed's bond-buying spree from 2009 to 2014, dubbed quantitative easing, inadvertently left the industry flush with deposits. Investors took money they got selling mortgage-backed bonds and Treasury securities to the Fed and parked it in U.S. retail and commercial bank accounts.
This created some $2.5 trillion in excess bank deposits, according to JPMorgan. It estimates that 60 percent, or $1.5 trillion, of that money will trickle out of banks in the next four to five years if the Fed follows through with recent guidance and begins reversing quantitative easing in December.
The Fed is currently holding about $4.5 trillion of securities. The way it will get rid of them is by letting them mature and not buying new ones.
JPMorgan's presentation, titled "Core Deposits Strike Back" illustrates how this process will sap bank deposits using the example of a couple who pays off a mortgage that was bundled with other mortgages and sold to the Fed. Right now, when that couple takes that money out of their bank account for that payment, the Fed uses that cash to buy another mortgage bond, recycling it back into the banking system.
A "deposit is destroyed" if the "Fed does not reinvest," the presentation states.JPMorgan estimates that a quantitative easing-related deposit-drain could result in loan growth lagging deposit growth by $200 billion to $300 billion a year.
That could be particularly problematic for banks that rely on deposit products that tend to roll over swiftly, such as brokered accounts bought from third parties, large commercial banking accounts and high-interest savings accounts for wealthy customers.
It may also set off a dash for retail deposits, a classification that includes bread-and-butter checking accounts, which banks love because they are especially cheap and stable.
Midsize banks will have an especially hard time growing retail deposits by ramping up advertising and investing in branches, according to JPMorgan's presentation. That's because they lack the marketing muscle of mega banks such as JPMorgan itself, as well as Wells Fargo & Co., Citigroup Inc., and Bank of America Corp. JPMorgan, like some other banks, offers depositors cash incentives for opening new checking and savings accounts with five-figure balances.
About 42 percent, or $1.6 trillion, of the new deposits that U.S. banks have amassed since late 2009 have gone to lenders with at least $1 trillion in assets, according to data JPMorgan compiled from regulatory filings and SNL Financial.
"Large banks are making sizable investments in brand, customer acquisition and technology leading to market share gains," according to the report.
Since big banks have the wherewithal to hold onto those gains, smaller ones may have to consider selling or buying rivals to bulk up on retail deposits, JPMorgan argues.
"The need for retail deposits to fund loan growth, the challenge of organically originating new relationships and the scale required to support technology and brand investments will drive consolidation," the report states.
A looming push for retail customers may already be spurring dealmaking, JPMorgan says, noting that a handful of bank mergers have involved targets with heavy concentrations of deposits purchased from brokers or acquired through listing services such as QwickRate, both of which are more expensive funding sources than retail accounts.
The examples include BNC Bancorp's $2 billion sale to Pinnacle Financial Partners Inc. and PrivateBancorp Inc.'s roughly $5 billion agreement to sell to Canadian Imperial Bank of Commerce.
The median for deposits in the form of brokered and listing-service accounts for U.S. banks with at lease $1 billion in assets was 2.5 percent at the end of 2016, according to data from SNL Financial. Those types of funds accounted for more than 20 percent of deposits at BNC Bancorp and PrivateBancorp, according to regulatory filings.
Deposit needs factored into both banks decision' to seek a partner.
Selling to Pinnacle is "an excellent opportunity to really drive some really, serious, dynamic deposit growth to fund this machine over the next several years," BNC Bancorp Chief Executive Officer Richard Callicutt said in a conference call with analysts in January.
PrivateBancorp urged investors to vote in favor of its deal with CIBC in a shareholder presentation last month to help "address standalone funding constraints" by giving it access to a large retail deposit base.
Selling to CIBC will help PrivateBancorp when interest rates rise, Terry McEvoy, a Stephens Inc. bank analyst, said Monday in a research note to clients.
"We have long felt the company needed to improve their funding base to support loan growth," McEvoy said in the note. "To do so on a standalone basis would be expensive and difficult."
Proxy firm Institutional Shareholders Services Inc. has advised PrivateBancorp stockholders to reject the deal because it undervalues the Chicago-based lender. A shareholder vote is schedule for Friday.
