JPMorgan Chase (JPM 0.15%) continues to hold an outsize position in cash, a strategy it has largely followed since interest rates started to move higher after they quickly dropped to zero at the beginning of the pandemic. This approach was previously doubted by some given the higher interest rate environment, in which the bank could deploy cash into shorter-term bonds yielding more than 4%, which would certainly bolster earnings in the near term. But as the banking system has started to see pressure on liquidity, JPMorgan's choice to hoard cash now looks like a smart strategic move. Here's why.
Managing liquidity at an unpredictable time
Toward the end of 2020 through roughly the first half of 2022, banks were awash in deposits thanks to elevated consumer balances due to built-up savings and stimulus, as well as the Federal Reserve's quantitative easing program, where it was buying bonds and injecting trillions of dollars into the economy.
As the economy normalized and interest rates rose, banks have moved to deploy deposits into loans but also into bonds as their yields increased. All banks have done this to some extent, but at the end of 2022, JPMorgan was still holding more cash than its peers.
| Bank | Cash and Cash Equivalents | Total Assets | Cash as a Percentage of Assets |
|---|---|---|---|
| JPMorgan Chase | $567.2 billion | $3.67 trillion | 15.5% |
| Bank of America | $230.2 billion | $3.05 trillion | 7.5% |
| Citigroup | $342 billion | $2.42 trillion | 14.2% |
| Wells Fargo | $159.2 billion | $1.88 trillion | 8.5% |
Data sources: Bank financial statements.
When rates started to rise, hoarding cash may not have looked like the best idea. But now, as the Fed raised rates aggressively and began the process of quantitative tightening (QT), which effectively pulls liquidity out of the economy, bank deposits started to face pressure from all sides. Higher rates drive customers to chase yield and deposits are draining from the banking system because of QT.
"The recognition that with QT coming, all else equal, deposits are going to come down, and it's just easier and more straightforward to let that flow out of the cash balances rather than have to readjust securities positions when that happens," JPMorgan CFO Jeremy Barnum said at a recent financial forum.
Essentially, what Barnum is saying is that covering deposit outflows with cash is easier and less costly than having to sell bonds that might be trading at a loss to cover unexpected outflows. Because the Fed raised rates so quickly, the deposit picture is quite murky. Barnum added that with short-term yields currently higher than long-term ones, it gets difficult to buy bonds that mature too far out because you can quickly run into duration risk.
Still, it's not like JPMorgan hasn't deployed cash over the last year. Cash and cash equivalents at the bank are down by about $172 billion between the end of 2021 and the end of last year.
Meanwhile, Citigroup, which was holding 14% of its total assets in cash and cash equivalents, has actually significantly increased its cash balances over the last year. Citigroup is currently undergoing a big transformation, so I think it's managing its balance sheet differently than it would under more normal circumstances.
A prudent move
Despite not deploying as much cash as it could have, the decision appears to have paid off for JPMorgan. The bank still delivered strong fourth-quarter earnings results, as well as for the full 2022 year, and now has left itself in a much more flexible position.
Should deposit outflows accelerate, the bank has a lot of cash on hand to use before having to dip into its securities book.
Also, if the Fed ends up raising rates more than anticipated, JPMorgan has more cash to deploy into higher-yielding bonds. Strong liquidity management is just one of the many reasons investors pay up to buy JPMorgan's stock.
