BOUTIQUES OFFER NEW CASH PROTECTION AS A U.S. GUARANTEE ENDS / THE NEW YORK TIMES

December 30, 2012

Boutiques Offer New Cash Protection as a U.S. Guarantee Ends

By NATHANIEL POPPER and JESSICA SILVER-GREENBERG

 

 

On the first day of the New Year, $1.5 trillion of bank deposits will lose an unlimited government guarantee that was granted during the financial crisis to assure skittish customers that their cash was safe. For a handful of boutique firms that service banks, it’s a boon for business.

 

      

The accounts losing the insurance are used by businesses, municipalities and other entities like nonprofits that are willing to forgo any interest in order to have immediate access to their large pools of cash.

 

      

These accounts hold about 20 percent of all deposits in United States banks. Starting Jan. 1, only $250,000 in each noninterest bearing account will be backed by the Federal Deposit Insurance Corporation.

 

      

Now a scramble is under way to make sure these customers do not withdraw large sums out of banks, particularly community banks that have benefited from the guarantee. Because a depositor is barred from spreading out $1 million into four accounts within the same bank, many smaller banks are turning to a handful of specialized cash-management firms that can split up deposits into multiple $250,000 chunks and distribute them among a network of banks, each of which can insure $250,000.

 

       

One firm doing this parceling work, Reich & Tang, has had an influx of 25 new banks in the last few weeks sign up for the program, a 20 percent growth. Deposits managed by another firm, StoneCastle Cash Management, have surged to roughly $3 billion from just over $2 billion in September. “Interest has picked up dramatically,” said Joshua Siegel, managing principal of StoneCastle.

 

      

The end of the unlimited insurance, known as the Transaction Account Guarantee, is the latest twist in the government’s effort to scale back its support for the financial system, and the banking industry’s effort to mute the impact of the new lower limits.

 

      

Many analysts assume that even with the end of the government guarantee, the vast majority of the deposits will remain in the banks because the government will continue serving as some sort of backstop for most of the $1.5 trillion.

 

      

For small banks, there are programs like Reich & Tang’s, with the government fully insuring the scattered deposits. For the nation’s largest banks, there is a widely shared assumption that the government would be forced to provide a backstop to protect depositors in a crisis, as it did in 2008. 


“Implicitly or explicitly, most of this money is going to still be guaranteed,” said Bruce Hinkle, an executive with Farin & Associates, a consulting firm that works with banks.

 

      

The unlimited guarantee was created in the depths of the crisis by the Federal Deposit Insurance Corporation, in order to stop a migration of customers from smaller banks to larger ones that were viewed as less likely to fail.

 

      

Most individual savers keep their money in interest-bearing accounts, where since the crisis the insurance coverage was raised to $250,000 from $100,000. Some families have gotten around the insurance limit by dividing money into separate $250,000 accounts under the names of different family members.

 

      

Firms like Reich & Tang will do this more systematically for wealthy clients. The end of the unlimited guarantee for corporate and municipal depositors is set to significantly increase business at these firms.

 

      

Mr. Siegel, managing principal of StoneCastle, which runs one of the largest programs, said he has seen a tenfold increase in interest from community banks in the last month. Begun in 2011, the service, called the Federally Insured Cash Account program, distributes large deposits throughout a network of roughly 500 banks.

 

      

StoneCastle and other firms make money by charging banks a small percentage of any deposits they distribute, generally less than 0.2 percent.

 

      

Frederick L. Cannon, a bank analyst at Keefe Bruyette & Woods, said that the expansion of the practice from wealthy individuals to corporate customers makes the F.D.I.C.’s limits toothless and exposes the government to more risk if banks fail in the future.

 

      

“You want these limits so there is some kind of market discipline on these banks,” said Mr. Cannon. “If I were on the F.D.I.C. board, I would be concerned about this.”

 

      

The F.D.I.C. hasn’t taken any position on the cash management companies, but a spokesman said that it’s important to ensure strict record-keeping so there is a full accounting of where the deposits end up.

 

      

Tom Nelson, the chief investment officer at Reich & Tang, said that by spreading money among banks, his firm and others like it increase the stability of the banking system and that the practice “reduces the risk of runs on banks.”

 

      

The F.D.I.C. guarantee was one of a number of factors that encouraged depositors to shift money into noninterest bearing accounts after the crisis. Since 2011, when the account guarantee program was extended as part of the Dodd-Frank financial regulation law, the amount of money in such accounts rose by 70 percent, or $678 billion, according to Alex Roever, a JPMorgan Chase analyst.

 

      

The vast majority of the holdings in these accounts are above the $250,000 limit and are held in the nation’s largest banks. That money is expected to stay put no matter what, in part because corporations and municipalities widely believe that the government will step in if those large banks encounter trouble, effectively considering them too big to fail.

 

      

In recent months, as the deadline loomed, community banks fiercely lobbied for the program to be extended, arguing that it helped level an uneven playing field that favors large banks. The smaller banks said that without the unlimited guarantee, the nation’s largest banks would win an even greater concentration of total customer deposits. Congressional leaders at first appeared ready to continue the guarantee, but this December decided against it, saying that it threatened to allow more bank bailouts.

 

       

Before the latest financial crisis wiped out hundreds of banks and left Wall Street teetering on the brink of collapse, many depositors were comfortable keeping large sums in accounts even if there was no government guarantee. But with the memory of bank failures still fresh, customers are more aware of the inherent risks involved.

 

      

Frank Sorrentino, the chairman and chief executive of North Jersey Community Bank in Englewood Cliffs, N.J., signed up with StoneCastle to have a product in place to offer any worried corporate clients.

 

      

The insurance “isn’t even dead yet and it’s just nice to know that we have an answer for any clients that are concerned,” Mr. Sorrentino said. The bank, where 7 percent of its $724 million in deposits are in T.A.G.-insured accounts, also has been approached by other firms pitching the cash management service. So far, Mr. Sorrentino has said that only a handful of clients have asked about how the insurance expiration might imperil their cash. With the cash management option in place, he said he is confident that money will stay with his bank. Bank analysts at FBR Capital Markets estimate that concerned depositors may move around $250 billion out of the noninterest bearing accounts in the coming months, most of it from smaller banks to money market funds, which received a government safety net during the crisis, or to larger banks.

 

      

But other banking analysts say that the doomsday predictions of community banks are overblown. Mr. Cannon of Keefe Bruyette said that institutional investors were unlikely to move large sums because the waves of cheap funds for banks have decreased the chances that community banks will encounter any trouble. What’s more, Mr. Cannon said, the government ended up standing behind a large proportion of even the uninsured deposits at banks that failed.

 

      

Jeffrey Esser, the executive director of the Government Finance Officers Association, said that his organization has made municipal treasurers aware of the end of the unlimited guarantee, but few had expressed alarm.

 

      

Mr. Cannon expects that if money does move, it will go in to ultrasafe Treasury securities and mortgage-backed bonds that pay at least some interest. Economists at Goldman Sachs said recently that this flow of money could exert a further downward pressure on the yield offered by the benchmark 10-year Treasury note, which has dropped to 1.7 percent from around 5 percent before the crisis.

 

      

The biggest winners could be the cash management providers. Mr. Hinkle, the executive with bank consultancy Farin & Associates, said that the largest such program is run by the Promontory Financial Group, which will take a maximum of $50 million from each customer and spread it among a network of 2,500 banks. A spokesman for Promontory didn’t return calls for comment. 


      

Steve Shear, who heads up cash management at First Western Trust in Colorado, said he decided to sign up for Reich & Tang’s program in recent months as it became clear that the guarantee program would not be expanded. While his customers didn’t have the deposits insured five years ago, the crisis has made them accustomed to the government backstop.


 

“Even though it’s only been in place for the last four years, people have grown very accustomed to having that security blanket,” said Mr. Shear. “Having that insurance is a nice safety net.”