Life After Full FDIC Insurance

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1 APRIL 2012 Life After Full FDIC Insurance Table of Contents EXECUTIVE SUMMARY Overview...2 A Slow Burner...2 Yield...3 Liquidity...4 Risk...4 Conclusion The Dodd-Frank Act was the hallmark piece of legislation intended to shape the banking sector in the wake of the financial crisis. An often overlooked piece of the legislation and one that has key implications for corporate treasurers is the extending of full FDIC insurance on noninterest-bearing transactional demand deposit accounts (also known as primary checking accounts, operating accounts, or NIB DDAs). This provision has afforded many corporate treasurers full insurance on their cash in 2011 and 2012, however it is scheduled to expire on December 31, Come January, corporate treasurers will most likely be considering options for the best place to deposit their corporate cash without the benefit of full insurance, looking, as always, to strike that delicate balance between safety, liquidity and yield.

2 Life After Full FDIC Insurance 2 overview The Dodd-Frank Act was the hallmark piece of legislation intended to shape the banking sector in the wake of the financial crisis. Passed in 2010, the bill includes well-known provisions such as the Volker Rule, which sets limitations on proprietary trading; the Durbin Amendment, which establishes controls around consumer debit card rates; and Reg Q repeal, a reversal of a regulation dating back to the Great Depression, now enabling banks to pay hard-dollar interest on commercial checking accounts. An often overlooked piece of the legislation, however and one that has key implications for corporate treasurers is the extending of full FDIC insurance on noninterest-bearing transactional demand deposit accounts (also known as primary checking accounts, operating accounts, or NIB DDAs). This provision has afforded many corporate treasurers full insurance on their cash in 2011 and 2012, while they enjoy a yield in the form of earnings credit (soft-dollar credit to offset banking fees). This provision, however, is scheduled to expire on December 31, Come January 1, 2013, corporate treasurers will most likely be considering options for the best place to deposit their corporate cash without the benefit of full insurance, looking, as always, to strike that delicate balance between safety, liquidity and yield. A SLOW BURNER To start with, NIB DDA insurance was a relatively little known provision embedded within a bill of far-reaching implications. As the economy seemingly continued its road to recovery through January 1, 2011 (the date full NIB DDA insurance became effective), the importance of having a fully insured operating account did not seem critical, especially if an account was maintained at a major money center bank with a large balance sheet. However, as the events of 2011 unfolded including the debt ceiling crisis, the subsequent S&P downgrade on U.S. debt, and the continuing European debt crisis a fully insured account became more attractive, especially given the added benefits of daily liquidity and an attractive earnings credit rate. But just as treasurers are beginning to get used to the backstop of FDIC insurance on NIB DDA accounts, its days are likely numbered. While Congress can amend the Act to extend the period of full insurance, the Dodd-Frank legislation stipulated that it will extend only through 2012 and there have been no overtures by Congress to suggest this will change. Nor has the FDIC stipulated that it will independently introduce a program to extend full insurance. As the events of 2011 unfolded, a fully insured account became more attractive, especially given the added benefits of daily liquidity and an attractive earnings credit rate.

3 Life After Full FDIC Insurance 3 Once full insurance ceases to exist, corporate treasurers will most likely reassess their cash allocation decisions and ascertain how much cash to leave in their NIB DDA. So how will NIB DDAs compare to other deposit and investment options in 2013? This question is best answered by referring to the three pillars of cash management decision making: yield, liquidity and risk. YIELD Unfortunately, with Fed Fund Futures now indicating that a material uplift in the short-term interest rate environment is unlikely before 2014, corporate treasurers will see few opportunities to capitalize on yield, regardless of which vehicle they opt for. Unless treasurers can tie up cash for six months or more something most corporate treasurers are reluctant to do with funds that might be required for more immediate needs there are few attractive options now and in the foreseeable future for short-term cash. As corporate treasurers review their options, the rate offered by many banks on the NIB DDA will likely remain competitive with other deposit alternatives such as money market savings accounts and various sweep vehicles. This is primarily because the earnings credit on a NIB DDA acts more like a discounting of cash management services than a payment of hard dollar interest, which allows banks to focus more on reducing fixed and variable costs associated with their treasury services business to improve their margins. In addition, the relative long-term characteristic associated with commercial operating accounts, makes the NIB DDA an attractive funding source, enabling banks to pay more for the value associated with this product. While yields on any short-term cash product will not be particularly appealing, considering the premium that banks put on maintaining and promoting operating accounts, corporate treasurers might see attractive earnings credit rates for the foreseeable future. Corporate treasurers will see few opportunities to capitalize on yield for short-term cash. While yields on any shortterm cash product will not be particularly appealing, considering the premium that banks put on maintaining and promoting operating accounts, corporate treasurers might see attractive earnings credit rates for the foreseeable future. Beyond short-term bank deposits, treasurers will likely find higher yields in money market funds if they search hard enough for prime funds, especially in instances where providers are discounting fees. While it might make sense for corporate treasurers to carve out a portion of their reserve and strategic cash to these funds, there are operational challenges associated with money market funds when that cash becomes necessary for working capital and operating needs. If directly invested, a corporate treasurer needs to redeem shares and move funds to an operating account. This requires incremental operation attention vs. passive bank deposits and, depending on levels of activity, can significantly increase costs. In addition, with the proposed money market mutual fund reforms from the Securities and Exchange Commission that may ultimately result in a floating Net Asset Value (NAV) and partial redemptions for these funds, the attractiveness of this cash management product may decrease.

4 Life After Full FDIC Insurance 4 Aside from money market funds, an additional pick-up in yield might be achieved using short-duration bond funds, commercial paper, term repos, etc. There are risks unique to each of these instruments, however, that can diminish their attractiveness for operating and reserve cash. Short-duration bond funds, for instance, carry principal risk, which generally causes such investments to fall outside a corporate treasurer s investment policy for operating and reserve cash. When all options are considered, from a yield perspective it is likely that an NIB DDA with an associated earnings credit rate may remain a very attractive option for businesses that routinely utilize cash management services and have banking fees to offset. Liquidity The ability to access cash immediately, and move it anywhere globally in real time, is not a luxury but an essential aspect of business management. While corporate treasurers recognize that they can optimize yield and manage risk by placing cash along the yield curve in various low-risk instruments, they require daily access to the majority of their funds in order to meet working capital requirements and capitalize on business opportunities when they arise. While several investment options offer daily liquidity (e.g., money market funds, overnight time deposits, money market savings accounts, etc.), the NIB DDA, which offers daily liquidity and unlimited transactions, is often viewed as the cornerstone of a business operations from a flow of funds perspective. As corporate treasurers weigh product options that allow for seamless movements of cash, in terms of liquidity and accessibility, the NIB DDA is always a preferred option. The ability to access cash immediately, and move it anywhere globally in real time, is not a luxury but an essential aspect of business management. Risk Security has been the top cash management priority for the past five years. While the NIB DDA will no longer benefit from the FDIC backstop of full insurance come 2013, it has other characteristics that should be factored in when comparing its risk profile to that of other cash alternatives. The most important consideration is the underlying institution where the account is held. This dictates how secure a business cash is, and can be monitored using metrics such as Tier I Capital Ratio, overall deposit base, time to required funding and whether the institution is likely to be considered a Strategically Important Financial Institution (SIFI) or large Bank Holding Company (BHC) as defined by the regulatory frameworks of Dodd-Frank and Basel III. These metrics may indicate that the NIB DDA has a favorable risk profile than other cash alternatives.

5 Life After Full FDIC Insurance 5 Surveying the landscape of the various cash management products from a risk profile unveils the fact that bank risk, particularly with all the new regulation and controls in place, is likely on-par-or-better than other short-term alternatives. Even without full insurance, it will benefit the corporate treasurer to objectively assess the risk of their company s DDA to determine whether the value of an ECR with a systemically strong bank is a potentially favorable risk trade-off than placing funds in more volatile alternatives. Conclusion All good things must come to an end, and full FDIC insurance on transactional NIB DDAs is no exception. When the explicit guarantee from a federal agency is removed, corporate treasurers will be prompted to review their cash and asset allocation to ensure an appropriate risk/return trade-off. However, they will not necessarily conclude that the NIB DDA has become riskier than other products. In fact, depending on some of the underlying characteristics of the depository institution where the DDA is held, the risk profile of this option may very well be significantly more attractive than the alternatives. With a low-risk profile, a relatively attractive yield and the ability to offer unlimited transactions, the NIB DDA may continue to be a corporate treasurer s top choice for operating balances in Bank of America Merrill Lynch is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation ( Investment Banking Affiliates ), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., both of which are registered broker-dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured May Lose Value Are Not Bank Guaranteed Bank of America Corporation BA-AD-0296ED