The ongoing flight of capital to higher yield

Banks are going to have to adapt

Capital has a habit of seeking the highest yielding, lowest risk investment possible. For a very long time, with interest rates near zero, this meant being forced to take on some risk in order to get any sort of acceptable return. Since the stock market was on a tear, this generally meant most capital got invested into the market, which continued to raise the price of equities, which meant more capital went into the market, fueling a bull market that lasted almost a decade.

Risky investments built upon risk-free capital such as VC and PE were also very appealing. PE has always generated phenomenal returns although was only available for select few. VC has always been risky, more of a diversification and “prestige” investment. In other words, if you made the right VC investments, you were seen as the smartest investor in the room, which is very valuable when reputation means so much in this industry.

However, times have changed. Due to inflation, interest rates are very high, and there are suddenly much less risky ways to make alpha and the returns from other typical asset classes like equities, VC and others have gone down.

But let’s talk about dry powder. Companies and ultra high net worth individuals do keep a lot of their assets in cash for when investment opportunities present themselves or as working capital, especially recently as other asset classes have become riskier. So the banks that specialize in handling these type of clients (i.e. private high net worth banking) have been sitting on large amounts of cash. Places like Chase, Citigroup, Charles Schwab, and State Street.

Well, that appears to be changing rapidly.

The Financial Times reported today that “Charles Schwab, State Street and M&T suffered almost $60bn in combined bank deposit outflows in the first quarter.” Now, $60bn is a drop in the bucket, but it represents non-insignificant amount of this type of deposit at these institutions. For instance, it was an 11% drop in deposits in the quarter for Schwab and 30% year over year.

So why is this happening? Quite simply because these banks offer little to no yield on these deposits. According to the article, “the average US bank account savings rate is just 0.37 per cent,” which, quite frankly, is asinine considering the Fed’s benchmark rate is 5.0%. I personally have a locked in savings account at UFB direct at 5.02%, higher than almost every other bank’s 24 month CDs. And yesterday, Apple launched an incredibly easy to use savings account at a rate of 4.15%, a rate 1121% higher than your average bank, which is even higher than Goldman Sachs’ own Marcus High Yield savings product at 3.90%.

Quite simply, people are tired of getting nothing for having their money on deposit when they can earn free money elsewhere. More specifically, these are corporate and Ultra High Net Worth individuals and they realize they can get a very nice return at another bank, frequently even higher than the rates I’ve mentioned since they are depositing such large amounts of capital.

Now, as my private banker told me, it’s not really the business model of these specialized banks to provide returns on savings (and their very low savings rate demonstrates that), so they may not be sweating it. They provide specialized and personalized services unavailable at other banks to these kind of clients. But moving 90% of your capital to a high return account means you can get the yield on most of your cash and keep access to all of those services. It’s not like Chase is going to cut off a client simply for seeking a higher rate of return.

Now, $60 billion is still not very much. The 13 top companies in the S&P 500 are sitting on over $1 trillion in cash with Apple alone holding over $200 billion (although I believe they own their own bank and manage it like a hedge fund). But it certainly signals that capital flight to yield is accelerating, especially as interest rates at competing banks are rising. Companies would be stupid to not take advantage of high rates of return on deposits and I can only assume we’ll see more and more capital leave large banks unless they raise rates, which I doubt they will.

What an interesting time in banking.