Pub. 4 2016 Issue 4

Issue 4. 2016 13 So far, many investors haven’t completely exited the money fund market, but have largely transferred to government funds. Since October 2015, assets in government funds have nearly doubled, from around $1 trillion to nearly $2 trillion. Source: Crane Data’s Money Fund Intelligence So how could this benefit banks? 1. Institutional investors are shifting their investment strategies. Institutional investors have an array of options when it comes to managing their cash deposits, and once a strategy is institutional- ized, it takes work to go back and evaluate new options. In fact, for many institutional investors, investment practices are written into policies, further increasing the difficulty in reevaluation. This structure often leads investors to live by the idiom, “If it’s not bro- ken, don’t fix it.” However, the SEC rule change has effectively “broken” the investment policies for many institutional investors, triggering a reevaluation of investment practices. This opens a window of opportunity for banks. Banks are a trusted resource for institutional depositors and have played a growing role in institutional investment strate- gies since the financial crisis, even before MMF rule changes. According to the AFP’s 2016 Institutional Cash Management survey, institutional money managers allocate 55% of short- term portfolios to bank deposits. For context, the same survey from 2007 showed just 27% of short-term institutional funds allocated to bank deposits. Using Promontory’s Insured Cash Sweep service, or ICS, banks have the ability to offer institutional cash managers the same kind of safety of principal and liquidity that they previously expected in prime funds, without having to lock up the deposits in collater- al or repo sweeps. 2. Institutional investors will have fewer cash management options. Not all institutional investors will be impacted by MMF reform. Institutions that historically have had a greater tolerance for risk and variance in their short-term investments won’t see much of a shift in their practices. But many other institutional investors will face the prospect of a diminished range of short-term investment options. Many institutions are governed by rules that require a guarantee of principal on any deposit. Changes in MMF reform have these risk-averse entities moving deposits out of MMFs or adjusting their investment practices to invest solely in government-backed investments, such as treasur- ies or agency notes, which has significantly reduced the yield on these instruments. Again, bank deposits end up looking like an attractive option for many investors. With fewer investment options offering security for cash deposits, banks should be able to draw in safety-con- scious institutional depositors, particularly by using ICS. The ICS service provides insurance on large-dollar deposits with daily liquidity options. 3. Yield expectations are likely to adjust downward. Banks should be aware of the potential impact of MMF reform on customer interest rates. As MMF reform rules go into effect and institutional depositors move their funds to investment op- tions that offer stability, they will expect to pay for this safety. For banks, this change in expectations could mean that entire cus- tomer classes become more profitable. The true safety-conscious customers will be comparing bank rates against government MMFs. At the end of September, the top government money funds were yielding less than 30 bps, below what many banks would be willing to offer for these same deposits. With the lure of the higher yields paid by MMFs gone or severely reduced, much of this money will migrate back to its traditional home: banks. And by using ICS, banks have the flexibility to negotiate the rate directly with the institutional depositor, balancing bank and depositor priorities. This could hardly come at a better time for banks, particularly for community banks, which have had a harder time attracting new deposits, according to recent FDIC data that shows most deposit growth centered in larger banking institutions. The exact impact that a flood of institutional deposits could have on customer rates is still uncertain, but for reasons stated, it could have a moderating influence on deposit rates. Given this confluence of factors, as the fallout from money market fund reform settles and the environment for institu- tional deposits becomes clearer, banks may very well continue to grow as an essential partner to these depositors, and ICS could be an essential tool for banks looking to take advantage of this opportunity. n © 2016 Promontory Interfinancial Network, LLC. About the Author Glenn Martin is a Regional Director at Promontory Interfinancial Network. Promontory provides unique balance sheet and liquidity management services, including CDARS, ICS, IND, Yankee Sweep, Bank Assetpoint, and Residential Mortgage Network for members of its nationwide network of banks. For more information, contact Glenn at (866) 776-6426, ext. 3462 or gmartin@promnetwork.com. www.promnetwork.com