Short-Term Investing Series by Federated Hermes – Part 3: Bank Deposits versus Money Market Funds

[00:00:00] Intro: Welcome to the Treasury Update Podcast presented by Strategic Treasurer, your source for interesting treasury news, analysis, and insights in your car at the gym or wherever you decide to tune in.

[00:00:16] Craig Jeffery: Welcome to the Treasury Update Podcast. Safety, liquidity, and yield are always top of mind for investing and for investors. And on the short end of cash, there are several primary ways of intentionally or unintentionally investing. Bank deposits, which may have earnings credit rates, hard interest, no interest, et cetera. And institutional money market funds. I am delighted to be joined by Sue Hill and John Mosko. Welcome to the podcast.

[00:00:42] Susan Hill: Thanks, Craig. Nice to be here.

[00:00:43] John Mosko: Hey, Craig.

[00:00:44] Craig Jeffery: Let’s get started. So as we explore this topic of bank deposits and money market funds, Maybe for background, Sue, you could go into some of the numbers that help us understand the space. How have these numbers changed over time, the size of the market, where money’s moving, those types of background factors.

[00:01:06] Susan Hill: Yeah, thanks, Craig. So if we take a look at money market funds, the size of the money market fund industry relative to total bank deposits, but I guess both side by side, let me start with the money fund space. So, and as an aside, let me just say that I think this discussion today is particularly timely given the current market environment.

[00:01:27] We all know we’ve been in an interest rate environment where short term Yields have been particularly attractive in the five percent five percent level. And I think from our perspective at Federated Hermes and our expectation of, of upcoming Fed action, we actually think we’ll, we’ll be at this five percent level for a little bit longer than anybody had thought earlier in this year.

[00:01:53] And that when the Fed does in fact decide to ease, it may be some time before they You know, really, truly get up to speed and it’s likely gradual gradual from the onset. So that means it’s a, it’s a great environment to talk about both back deposits and, and money market portfolios. In my role as portfolio manager for Federated’s government liquidity products, I’m obviously a little biased as we’re, you know, comparing these two classes, but we’ll talk about both today. So from a money market fund perspective, the total assets in money market funds actually just hit a record high, I believe this week of 6. 1 trillion dollars. Those assets are really concentrated in government money market portfolios which hover around 5 trillion dollars.

[00:02:37] So a good percentage of, of the total industry in those safe haven types of investments. Money market funds in terms of assets over the last year have increased about a trillion dollars, predominantly spurred by the regional bank crisis in March of last year, but have continued to gather steam in the second half of 2023 and into 2024.

[00:03:01] If we take a look back at just say, 10 years ago in 2014, on a relative basis money market fund assets were hovering. Oh, around 2. 7 trillion dollars at that time. So we’ve had, had some significant growth. in this space over that time period. If I flip to bank deposits, total bank deposits today in the banking system sit at 17. 6 trillion dollars. Those are down from their peak of over 18 trillion. In early 2022, but up from a decline in assets after the regional banking crisis last year where banking deposits hit a low of around 17 trillion dollars. But if we look back in time again, over that same time period, about 10 years or so ago, Total bank deposits were around 10 trillion dollars 10 years ago.

[00:03:59] So obviously significant growth there. The growth in both of these spaces, I think, could be tied pretty directly to the Federal Reserve and Federal Reserve action over the time period. And some of the, you know, the various crises that we’ve been faced with from a financial perspective. I think it’s interesting to dive a little deeper in bank deposits, though.

[00:04:18] So of that 17 trillion dollars, Interestingly enough, there’s 4 trillion of that balance that are in non interest bearing deposits, right, which earn nothing for the investors in the funds. And then on a relative basis, or also in context, the amount of uninsured deposits out of that 17 trillion dollars stands at around 8 trillion dollars.

[00:04:43] So 40 percent of total bank deposits are uninsured 22 percent of bank deposits sit in non interest bearing accounts.

[00:04:53] Craig Jeffery: Do those numbers, they, they can’t really capture when earnings credit rates are being applied. Let’s say on the non interest bearing accounts, can they, or?

[00:05:01] Susan Hill: I don’t think you can really tell because obviously the, the reasons why investors would, would stay in unassured deposit.

[00:05:08] Or in a non interest bearing deposit that that isn’t really visible on the surface. And that may have to do with, you know, banking relationships where they might get some other type of benefit out of that either access to to other types of financing or or or other services that they need or sometime in the institutional space.

[00:05:28] Obviously, some sort of earnings credit. Or tech credit that won’t be visible on the surface, but still is a, is a motivator for institutions to, to leave cash sitting in those types of accounts.

[00:05:40] Craig Jeffery: Yeah. Some of the bank failures, failures that were happening in 2023 and the FDIC actions to pick that up have have been resurfacing the news lately.

[00:05:50] ICD, you know, completed a study of counterparty risk. I’ve always been surprised by how little movement companies take to improve their counterparty risk, especially when things hit the news. Everyone’s very excited for the, the week or the weekend and a smaller percentage of organizations change what their behavior is.

[00:06:11] What can we, what can we, Learn from bank failures, fed actions? Since these issues continue to come up over at times and at different rates and speed.

[00:06:23] Susan Hill: If I start with the survey in general for their client survey, there was, there was one thing that kind of stuck out to me and they asked one of my all time favorite types of questions of essentially what’s keeping you up at night and what do you stare at the ceiling about it?

[00:06:38] And you know, and I’m very much in tune with risks to the to the overall financial markets. So the responses from their treasury clients, 74 percent of their treasury team said they’re highly or moderately concerned with counterparty risk with 80 percent being highly or moderately concerned with bank failure.

[00:07:00] So those two kind of tie together. And that’s in the aftermath of the March banking turmoil from last year. So definitely a concern and a focus, I think, from from an investor perspective. Now, to be fair, also on that list was, you know, geopolitical concerns, which I think probably should keep all of us up as well.

[00:07:17] But in this particular circumstance, I think they’re definitely reflected a, you know, a bit of concern about what took place last March and how mindsets may have changed. So if we take a step back, I think, to that March of, of 2023 time period a year ago, and I’m covering all ground, but the rapid failure of, of two banks in particular Silicon Valley Bank and Signature Bank.

[00:07:41] Which it was concerning in two ways or, or, you know, had, had two reasons. You know, one is sort of foundational fundamental reasons because of the dramatically rising interest rate environments, banks that held treasuries on their balance sheets found that they had treasury positions that were well underwater and well at losses.

[00:07:59] And obviously that knowledge, you know, from a fundamental perspective, unsettled Investors and depositors in these two banks that came into focus. But the other thing that I think was, was particularly noteworthy was the speed with which it became a crisis and the speed with which they failed. And we can, we can have, you know, social media to thank for for that.

[00:08:20] And, and the spotlight on Twitter and posting pictures of people lining up for their cash from, you know, from these individual banks. And that has really, I think, changed the calculus for a lot of investors about how they. think about banks that might be in trouble or investments that might be in trouble because of how quickly they can, you know, come into the spotlight and really mushroom into a crisis.

[00:08:44] So it’s, it’s changed it, you know, from, from the investor perspective, but has also changed it from a banking perspective. So banks that maybe thought they had sufficient reserves in hand or had a comfort level in their overall deposit base, maybe have changed, you know, in the aftermath of. Of how quickly things things unfold.

[00:09:04] So I do have a lot of conversations about counterparty risk in general, you know, from a financial institution perspective, both in terms of, of, you know, what we think about, you know, various competing bank products, but also in terms of management of our own portfolios, the types of investments and you know, issuers that we invest in and the very stringent credit analysis that we do to ensure that their overall You know, continue to be, you know, high quality, you know, well capitalized, you know, highly liquid institutions.

[00:09:37] Craig Jeffery: Sure. I’ll hold, I’ll hold some of my questions, but I want to bring John in too. So John, can you weigh in as well?

[00:09:43] John Mosko: Yeah, I think those are tremendous points. And I think Craig, Sue, if you think about, We won’t call them the good old days, but I mean, even just pre COVID, where social media maybe wasn’t as robust in the financial sector, from a distribution perspective, we’d always talk about making sure that the people that we interact with on a day to day basis were informed in case they were, got the questions from the C suite.

[00:10:08] I’m invested in this. They see something in the, in the newspaper, boss comes down and says, Do we own this or is this in our money funds or is, you know, what’s our bank exposure? And all of that would take, uh, it could be a day, maybe two. And Craig, you probably handle this in some of your podcasts and some of the things that you do now with banking apps and with the ability of a corporate treasure to move money off of their smartphone.

[00:10:38] With whether it’s face recognition or thumbprint recognition where the, the biometrics have allowed these folks to be able to move deposits, not being in the office or not even to have to make a telephone call exacerbates a problem where a problem may not even exist. To Sue’s earlier point. Making sure that we have appropriate liquidity on the front end. Credit research, with high quality names and counterparties and risk controls. And candidly, the transparency, you know, if you think about the Requirements that are around how the construction of a government money market fund portfolio is in terms of concentration, reporting, flows,

[00:11:25] It’s all there every day for people to see. And that in and of itself, I think gives investors and shareholders comfort. And it’s why the, the industry has grown in the way that it has over the last two years.

[00:11:38] Craig Jeffery: You don’t have that level of visibility into the bank portfolio, that issue of the, the speed at which it happens over 40 billion was moved out of Silicon Valley bank that Thursday, I think it was over 42 billion.

[00:11:53] It would have been more. If their systems were able to handle it they were selling as fast as they could, you know, you think back to. You know, Sue, you mentioned the pictures of people lining up the banks to get their money out, especially those that had amounts over the 250, 000 limit. That was another number that I know was floated around, was on social media and reported that overhang of uninsured deposits.

[00:12:20] If you don’t have that backstop and you’re concerned about the bank, now you really have to move the number of the number of corporations that we’re talking to other banks, trying to get account set up instantaneously was unbelievable. If you go back to the great depression, you know, people are lined up around the block for weeks before they could empty the funds out.

[00:12:42] Now it’s compressed to a day or hours. You know, it’s like I can move all my money out instantly if I can access the system. So speed has some good features, but it certainly makes the the idea of counterparty risk more, more important.

[00:12:55] John Mosko: It’s a reminder Craig of the utility of a money market mutual fund.

[00:13:02] Craig Jeffery: you know, Sue, you mentioned the stats on you know, 74 percent felt the risk was higher.

[00:13:06] They’re more concerned, highly concerned or moderately concerned, and 80 percent were. On the bank failure side, certainly that concentration on the bank failure side is more heightened. We have some survey results from, you know, surveys we’ve done, where we’ve seen how many people have actually made changes to what they do.

[00:13:27] Not just, I’m more concerned, like I’m not sleeping at night, but what are you doing? Are you taking melatonin? Are you, you know, exercising, you know, two hours before bed or whatever the, The activities, not many are taking actual steps to address counterparty risk, which is I’ve become a scold on that topic, but I won’t hammer that point much more, but it’s a, it’s a significant challenge.

[00:13:52] Keeping cash in operating bank accounts is rather common. You know, banks are good partners. They open their balance sheets to companies. So this makes tremendous sense. Operating, operating accounts are a good way of compensating the banks. They’re a good way of maintaining that operating activity. That can benefit the company and also the banks.

[00:14:16] So I’ve given some of the answers, but I’d love to have a little bit of a discussion on and maybe start with you, John. What are, what are some of the reasons that companies keep money in those accounts that are no interest or just soft dollar interest, like earnings credit rate?

[00:14:32] John Mosko: Yeah, sure. The earnings credit piece is reasonably straightforward, right?

[00:14:37] I think that most bankers for the larger banks or even the small – mid sized banks offer valuable services to their clients, whether it’s check clearing or lockbox or, you know, lines of credit, international payments, a myriad of things that Let’s be, let’s be fair, have a cost assigned to them. It costs money to have an infrastructure to do what they do in terms of credit.

[00:15:05] So for a corporation to keep balances that don’t pay interest, that do not pay interest, that have, we’ll call it earnings credits, assigned to that to offset. Those costs is totally valid. It makes sense. I think it’s, I think from a, the, the standpoint of a treasurer, if there’s a way for them to take expenses off.

[00:15:32] Off their sort of line items. It makes good sense. Now for others they think about how they can earn interest. And the reality of it is we fight candidly against inertia. I have my money there. It stays there. I don’t need to worry about it. And that was fine four years ago through the COVID pandemic.

[00:15:55] where the interest on that money was in the teens of basis points, if not single digits , that argument becomes less compelling. You know, one of the things we always talk about is the beauty, one of the beauties of a money market mutual fund. It’s a check on the interest that banks should pay their corporate clients.

[00:16:21] And in a free market, It just is a way for them to, to know where the market is on interest rates. So for a corporate client, you know, we try to remind them that at five and a quarter percent, the interest income is real money. And depending on the size of your cash balances can be real money to the bottom line of a corporation.

[00:16:45] So again, the, the, the re the reasons why banks or corporations keep money at banks despite the interest they earn on them is valid to a point. But in this environment, being tactical and optimizing the interest that you earn also makes good sense. And that’s where we come in.

[00:17:08] Craig Jeffery: There used to be a reserve requirement, which would reduce when it was 10%, it would reduce whatever earnings credit rate by 10%.

[00:17:16] And that assumes, and this is the big point that assumes that you received a comparable earnings credit rate to what’s available in the market. You know, we monitor and track our credit rates. It is not comparable. They’re not consistent. So many, many companies, you know, it’s a, it’s kind of this hidden rate that you don’t see until after the month is over.

[00:17:37] The companies that stay on top of things maybe earn a higher earnings credit rate. than others, but the spread and the average is really quite dramatically different than most of the other short term cash options for most companies. We study and track that. It’s, it tends to be more significantly off of the current rate than what you might assume from just a 10 percent reserve requirement.

[00:18:04] It’s far more significant. The two categories of money market funds and bank deposits, there’s pros and cons to both. And we’ve covered some of those. Maybe we can look at those three traditional criteria of safety, liquidity, yield. What are the concerns on safety access or liquidity and then performance yield?

[00:18:25] What are the pros and cons of each of these? A straightforward look at those. John, if you’d start us on that one.

[00:18:31] John Mosko: The first part is from the liquidity standpoint is that from the practitioner’s perspective, The myriad of uses of how they spend their money, whether it’s acquisitions, whether it’s interest coupon, interest payments on their debt servicing, if it’s paying salaries, paying utility bills or infrastructure investment, whatever those reasons are.

[00:18:54] Again, as I mentioned earlier on this podcast, just the transparency as it relates to flows on a daily basis. The minimal credit risk that folks that Sue and her team do on the portfolio access to seeing what the holdings are.

[00:19:10] It’s prescriptive in the sense of, I know what the weighted average maturity of the portfolio is on any given day, the weighted average life of the portfolio, all the things that the SEC has built into the construction of a money market fund, help the shareholder know exactly what they’re getting.

[00:19:27] Craig Jeffery: Well, let me probe one thing on there on the on the safety standpoint.

[00:19:31] So under, under $250,000, a bank deposits bank guarantee and FDIC insured. That’s probably as tight as you can probably get, but let’s say someone has $25,000,000. That’s where it changes, right? Cause it’s. $250,000 is now FDIC insured and then $24,750,000 is not insured by the FDIC.

[00:19:56] John Mosko: Right. And so there are companies in the marketplace that act as, I guess the best word would be aggregators that are canvassing banks around the country to create products that diversify into banks with purchases less than $250,000 to do that.

[00:20:16] And you’re right. I think at about 25 million. It become, it then becomes operationally inefficient, right? So you’re talking about what? 25… 100 different names that you’re using to purchase a 25 million investment.

[00:20:34] Craig Jeffery: Yeah. And I liked, I liked your your comments really about visibility to know where they are and have the daily access to it.

[00:20:40] Sue, any other items to weigh in there?

[00:20:43] Susan Hill: So a couple of things to add, at least from my perspective, when, when you look at deposits versus money market funds that, you know, and arguably, you know, both offer liquidity, you can get your cash when you need your cash, when, you know, when the sun is shining. So liquidity is really not, Not necessarily a differentiating factor.

[00:21:00] It really comes down to the difference between, you know, the deposit and an investment, right? You’re, making that choice. The rate that that a depositor earns on his deposit is determined and set by the bank. Not necessarily directly connected with the bank. rates that are available in the marketplace.

[00:21:19] And in contrast, in a money market portfolio, it is a direct pass through of interest rates movements in the market, depending on what’s taking place with respect to Fed policy and absence, any stated and highly visible fee that a money market fund might charge. In the more recent environment that we’ve been in, we spent a great deal of time talking about the concept of deposit beta because it’s front and center in a rising rate environment.

[00:21:45] So banks tend to adjust their deposit rates. They tend to be very sticky on the way up as, as rates rise, whereas in contrast in a, in a money market portfolio, because of the nature of the investments in the short term markets, those securities and the, and that fund yield adjust very quickly to, to Fed actions.

[00:22:06] So if we look back over this most recent, you know, aggressive tightening cycle from the Fed. Money market funds really adjusted one to one to the over 500 basis point increase in rates by the Federal Reserve, whereas banks adjusted something less than that. So institutional deposits adjusted, you know, much more than a retail deposit did, but it was not necessarily on a one to one basis because of the sticky nature of, of how those deposit rates are, are set.

[00:22:34] It does raise the question of what happens when, when rates start to fall again, because although deposit rates have been historically sticky when rates rise, they have been much more flexible when rates would fall because the bank could adjust to lower rates and have to pay a lower rate to their, to their overall depositor in that case.

[00:22:55] And money market funds, again, through their investments are very different. We have the ability to soften. the impact on rate declines through the types of securities that we hold. So it’ll be interesting to see how banks adjust to this shift in, in Fed expectations. There’s really kind of historically wide spreads between rates on money market portfolios and, and certain deposits in the aftermath of the rate hiking cycle.

[00:23:22] And it’ll be some time before that differential really narrows. I think.

[00:23:27] Craig Jeffery: some good points. Like, I guess when we’ve seen rates rise, banks tend to delay when they raise the rates that they offer. And it’s a proportion it’s, it’s a percentage of the total. It’s not a hundred percent when rates decline, they decline the full amount, usually instantly like same day. There’s not a delay at all.

[00:23:48] John Mosko: If not ahead of time.

[00:23:51] Craig Jeffery: Yeah, I guess that could, that certainly can be the case. So, so very good comments there. As we draw to a close on our time, I wanted to give both of you an opportunity for any final thoughts, you know, on this, you know, short term rates, bank deposits versus money market funds. Sue, I’ll give you the first shot and then John, you can jump in.

[00:24:10] Susan Hill: Thanks, Craig. I’ll be, I’ll be pretty brief, but you know, from a cash perspective, I think, you know, that the general theme is that cash is going to be king for, for a while longer. We’ve been through a, a pretty good time period and expect that to, to continue as the Fed may shift to an easing cycle, but that easing cycle is likely to be, you know, a little bit, Delayed relative to original expectations this year.

[00:24:33] And a little more gradual once it, once it takes place. So that I think leaves, you know, cash alternatives at the front end, money market funds in particular, you know, back deposits in general as, as being still very attractive and in the upcoming months, if not longer than that, you know, relative to other types of investments.

[00:24:54] Craig Jeffery: Certainly. And John?

[00:24:56] John Mosko: Thanks, Craig. Really appreciate working with you through these podcasts. I would say if you think about a portfolio of options for the corporate practitioners, how they invest their cash, diversification never hurts. So if that means you own some direct securities, fantastic, obviously liaise with your banks with deposits.

[00:25:18] But at the end of the day, especially given the magnitude of corporate treasury balances, which are only getting higher, it just makes prudent sense to earn a market interest rate and the government money market fund. Is the option for them. So, you know, diversification, great. But at the end of the day, for all the things we’ve discussed today, it makes a lot of sense.

[00:25:43] Craig Jeffery: Thank you so much, John and Sue really appreciate it.

[00:25:50] Outro: You’ve reached the end of another episode of the Treasury Update Podcast. Be sure to follow Strategic Treasurer on LinkedIn, just search for Strategic Treasurer.

[00:26:04] ​

Views are those of Federated Investment Management Company as of 4/22/24, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

You could lose money by investing in a money market fund.  Although some money market funds seek to preserve the value of your investment at $1.00 per share, they cannot guarantee they will do so.  An investment in money market funds is not a bank account and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Money market fund sponsors are not required to reimburse the funds for losses, and you should not expect that the sponsors will provide financial support to the funds at any time, including during periods of market stress.

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Due to various risks and uncertainties, actual events, results or actual performance may differ materially from that reflected or contemplated in any forward-looking statements. Nothing contained herein may be relied upon as a guarantee, or a representation of the future.

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