From the February 2009 issue of Treasury & Risk magazine

Idle Balances Reap Rewards

For decades, many treasuries' top priority was to sweep every available dollar out of a no-interest bank account into an interest-bearing investment or apply it to a line-of-credit balance. Now some of the most alert treasuries are reversing that pattern and taking pride in the money they leave in bank accounts. It's a dramatic change of direction, but recent dramatic events could make so-called "idle balances" actually the most rewarding use of cash.

First, in response to the financial crisis, Congress last October extended FDIC insurance temporarily to cover 100% of the money held in no-interest accounts like corporate demand deposit accounts (DDAs). "Temporary" means until the end of 2009. That coverage significantly reduces the risk of leaving large amounts of cash on deposit.

Second, banks have largely removed the 10% haircut they gave to funds left on deposit, technically to compensate for their reserve requirement, now that the federal government is paying interest on their reserves, notes Dan Gill, director of customer support training at Weiland Financial Group Inc., Chicago, a provider of bank account analysis and administration software. Now all funds left on deposit typically count toward the earnings credit rate (ECR), not just 90%, and that upgrade has changed the value calculation in favor of the
earnings credit.

Idle funds were never exactly idle. While banks by law could not pay interest on corporate checking balances, they could cover fees for banking services by calculating an ECR on funds left on deposit and then offset fees owed to the bank by the earnings credit. Corporations could buy banking services with hard dollars or with balances, but nearly all sophisticated treasuries chose hard dollars. Now they're rethinking that choice.

"The economics have shifted. Banks have started to make adjustments, but this has yet to play out at the corporate level," says consultant Dave Robertson, a partner in Treasury Strategies Inc., Chicago. Treasury managers will be reluctant to change cash mobilization machinery in response to an economic blip, but this recession may be more than a blip.

"We could be looking at a situation where idle balances left in bank accounts actually earn a better real return when applied to fees than balances swept and invested in the most conservative investments like treasuries or treasury funds," he notes. This could go on for another 18-24 months, he predicts--time enough to reward treasury departments that adjust their strategies to take advantage of the unusual spreads and inversions.

Investment patterns are ingrained and many treasury pros have not yet "put together all of the pieces of an optimal investment strategy for these times," notes James Haddad, vice president-finance for Cadence Design Systems, San Jose, Calif. "It makes no sense to wire funds into an outside investment vehicle when the return is only 25-30 basis points. It's often better to let the funds sit and take the ECR. We're taking a hard look at our own practices now that rates have fallen so low. It makes a lot of sense to leave enough balances to cover your banking fees."

Savvy treasury managers, Gill says, should:

o Confirm that their banks did not opt out of the expanded FDIC coverage and that 100%
of balances are credited toward the ECR.

o Pay close attention to the monthly account analysis statements from their banks, tracking the amount of fees they are paying and the ECR each bank
is offering.

o Compute the after-tax value of the interest they could earn by investing and the savings they could realize by using the ECR to reduce fees. Interest earned is taxable while using balances to cover fees is not taxable, Gill points out.

If they find the ECR to be more valuable than the investment return, then they should turn off automatic sweep features and leave funds sitting in bank accounts up to the point where all fees charged by that bank are covered. After that, excess balances become truly idle and should be invested, Gill says. Most companies settle monthly with their banks , but some shrewd treasuries have negotiated quarterly settlements, Gill reports, and can carry over one month's excess to apply against the next month's fees; they only have to be careful to invest the excess by the end of each quarter.

Where banks set the ECR is a business decision that depends on how badly they need funds. Naturally the ECR is falling along with other short-term interest rates, but some banks are pinched for liquidity and hungry for funds while others are awash in liquidity and have limited opportunity to use the cash profitably, which means the ECR is likely to vary from bank to bank, Robertson says.

Many bankers now see corporate balances as a more dependable and affordable source of funds than other options in this stressed market and make a marketing effort to attract them, Haddad says.

Cleveland-based KeyBank is emerging as an aggressive player. "Now that deposits are fully insured, we're reintroducing the concept of using soft dollars to pay service charges," says Jim Graves, senior vice president and head of treasury product management. Key uses tiered ECR pricing and has recently "collapsed a couple of the lower-dollar tiers and added a tier for $1 million plus," he says. Smelling an opportunity to build deposits, Key has "set our rates at pretty competitive levels to give treasury staffs an incentive to bring balances back to their DDAs," he explains.

Key's ECR is still below the bank's average cost of funds, so the more it can build corporate DDA balances, the more basis points it can shave off its average cost of funds. But the ECR is "significantly above the short-term money rates--above T-bills, above LIBOR, above Fed funds," Graves says, giving depositors a chance to improve effective yields. When they find attractive ECR returns, treasury staffs may actually want to consider sweeping balances from a DDA account at one bank to a DDA at another, he suggests.

Keeping more balances in a credit bank has another advantage, Graves says: "It helps prop up the client profitability metrics in the bank's system. We don't trade off balances for credit, but it gives us more flexibility to make credit decisions when we see a better picture of profitability and ROI for the bank." In other words, higher balances make you look like a more profitable customer to the bank.

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