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Hoarding: ‘Cash is King’

Posted by Larry Doyle on November 2, 2009 4:22 PM |

Why would corporations hoard cash? A variety of reasons. Let’s review two stories today that highlight this economic dynamic.

Bloomberg reports, Pandit’s ‘Near Death’ Hoard Signals Lower Bank Profits:

Citigroup Inc. and JPMorgan Chase & Co. are hoarding cash as if another crisis were on the way.

Citigroup has almost doubled its cash to $244.2 billion in the year since Lehman Brothers Holdings Inc. filed for bankruptcy, the biggest such stockpile of any U.S. bank. The lender, which last year came so close to a funding shortfall it had to get a $45 billion government infusion, is under pressure from the Treasury Department and regulators to keep more money on hand for emergencies, even as markets improve.

The caution, which may help restore confidence in the financial system, offers little comfort to shareholders, who can expect to see shrinking returns as banks put money into liquid investments that yield one-twelfth the interest rates of loans.

“It’s a smart longer-term move, but it will take down the rates of returns these companies can generate,” said Eric Hovde, chief executive officer of Washington-based Hovde Capital Advisors LLC, a hedge fund with $1 billion of financial-industry and real estate investments. “If you start to see more economic stabilization, then liquidity levels would start dropping, but they’ll never go back to the insane level they were pre- crisis.”

The four largest U.S. banks by assets — Bank of America Corp., JPMorgan, Citigroup and Wells Fargo & Co. — have increased their combined liquidity by 67 percent to $1.53 trillion as of Sept. 30 from $914.2 billion in June 2008, before Lehman’s collapse, according to the companies’ third-quarter reports. The amount equals 21 percent of the banks’ total assets, up from 15 percent.

The hording of cash is not merely occurring in the financial industry. The Wall Street Journal highlights Jittery Companies Stash Cash:

Stung by the financial crisis, companies are holding more cash — and a greater percentage of assets in cash — than at any time in the past 40 years.

[Nest Egg chart]

In the second quarter, the 500 largest nonfinancial U.S. firms, by total assets, held about $994 billion in cash and short-term investments, or 9.8% of their assets, according a Wall Street Journal analysis of corporate filings. That is up from $846 billion, or 7.9% of assets, a year earlier.

The trend appears to have continued in the third quarter, despite an improving economy. Of those 500 companies, 248 have reported third-quarter results. Their cash increased to 11.1% of assets, from 10.1% in the second quarter. Companies as diverse as Alcoa Inc., Google Inc., PepsiCo Inc. and Texas Instruments Inc. all reported big third-quarter increases in cash holdings.

“Everyone is hoarding cash,” says Carsten Stendevad, head of Citigroup Inc.’s financial-strategy group. He and others call that a hangover from the financial crisis a year ago, when companies couldn’t raise money or had to pay much higher rates than usual.

Why are all these companies, both banks and nonfinancial companies alike, hoarding cash? What are the reasons? What are the implications?

In my opinion, the reasons include the following:

1. limited loan demand
2. embedded losses on loans not yet recognized
3. increasing deflationary expectations
4. concern that liquidity and credit will tighten as Federal Reserve ultimately tightens
5. expectations that better opportunities to purchase businesses, companies, or other entities as economy remains weak

Cash is King!!


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