Bank cash cushions can soften U.S. credit blow

Tue Jul 26, 2011 7:22pm EDT

* Wall Street moves into liquid assets as default looms

* Record liquidity levels give banks advantage--experts

* Such low-yielding investments have weighed on earnings

By Lauren Tara LaCapra

NEW YORK, July 26 (Reuters) - Investors have long complained about cash sitting idle on bank balance sheets, but recently these cash cushions have become a lot more valuable.

As the U.S. lumbers toward Aug. 2 without an agreement to raise the debt ceiling -- and the threat of a U.S. downgrade or default looms -- banks with strong cash reserves are looking increasingly judicious.

Market experts say a downgrade or default would trigger higher margin calls across Wall Street on trillions of dollars' worth of transactions. On Monday, CME Group Inc (CME.O) became the first major clearinghouse to raise collateral requirements for trades backed by Treasury bills.

"In an environment like this ... you want to keep liquidity as high as possible," said Terry Belton, global head of fixed income strategy at JPMorgan Chase. "I think most firms have been trying to achieve that."

Belton and others involved with preparations by large banks said the industry has been moving into shorter-term investments that can be turned into cash immediately, even if interest margins suffer from weak yields.

Banks have also been reducing exposure to debt backed by U.S. agencies, such as Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB). Such bonds are also at risk of a downgrade if the U.S. government's rating is lowered and are viewed as less safe than Treasury bills.

Earlier this month, the biggest U.S. banks revealed hundreds of billions of dollars' worth of liquidity sitting on their balance sheets when discussing second-quarter earnings results. During conference calls, executives were grilled by analysts about their apparent cash-hoarding.

Goldman Sachs Group Inc (GS.N) said it had $166 billion in "excess" liquidity at quarter-end, representing 18 percent of its balance sheet. Chief Financial Officer David Viniar said Goldman "underperformed" during the period in part because it reduced risk and boosted the capital and liquidity it is holding to protect against market uncertainty.

Bank of America-Merrill Lynch analyst Guy Moszkowski was not impressed. Was the "liquidity drag" responsible for Goldman's miserly 6.1 percent return-on-equity number, he asked.

At Wells Fargo & Co (WFC.N), Chief Executive John Stumpf complained about rising cash reserves. He noted that Wells is "sitting on almost $90 billion of liquidity" that is not even earning the cost of Wells Fargo's deposits.

Still, Stumpf urged investors to give the bank credit for its caution.

"This wonderful deposit franchise we have is ... really undervalued in today's economic times," he said.

JPMorgan Chase & Co (JPM.N) said its "global liquidity reserve" was $404 billion, up 28 percent from three months earlier.

Questioned by Sanford Bernstein analyst John McDonald about all that liquidity sloshing around its balance sheet, Chief Financial Officer Doug Braunstein said the bank was not deliberately seeking low-yielding cash, but "just dealing with the deposits as they come in."

In hindsight, though, JPMorgan investors can take solace in the bank's well-oiled deposit-gathering machine.

"There's the potential for a near-term liquidity event," said Steven H. Turner, partner & leader of the risk practice at consulting firm Novantas, a consultancy that advises some of the 20 largest global retail banks. "The best way to deal with that is to stockpile liquidity." (Reporting by Lauren Tara LaCapra; editing by Andre Grenon)

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