Refocusing on Deposits

By Gregory S. Davis | September 24, 2008 AAA

Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) have been two of the most dominant investment banks on Wall Street. Over the weekend, the two banks agreed to change their tax status, allowing them to become bank holding companies. Investors should understand how these events are changing the banking industry and how the two banks will attempt to profit from the change in the future.

Changeover

The change in tax status effectively means that the former investment banks will now be able to conduct business as commercial banks like Wachovia (NYSE:WB) or JPMorgan Chase (NYSE:JPM). Morgan and Goldman will be allowed to accept customer deposits, and as deposit institutions, the former investment banks will now have access to liquidity via the discount window.

Discount Window?

The discount window allows eligible institutions to borrow funds from the central bank as necessary. It's basically a pressure-release system to help banks meet their reserve requirements. One of the biggest examples of its use was the day after the Sept. 11 attacks on the World Trade Center and Pentagon. Reserve banks set a one-day record at the time by lending $45.5 billion to depository institutions. (For more information about central banks, check out What Are Central Banks?)

Did You Say Accept Customer Deposits?

By looking at established commercial banks, investors can get a better handle on why going after deposit accounts is an attractive option. At the end of May, JPMorgan Chase reported a 15% increase in revenue for the second quarter over the prior year to $9.7 billion driven largely by its net interest income. Reasons given for the increase in net interest income were tied to:

1. Higher Loan Balances
2. Wider Deposit Spreads
3. Higher Deposits

Wells Fargo's (NYSE:WFC) Q2 revenues also increased 16% to $11.46 billion over the prior year. While it cites asset-based lending, credit cards and mortgage banking as a few of its key revenue drivers, it also notes the significance of its core deposits. Wells defines core deposits as checking accounts, savings certificates, savings deposits and certain foreign deposits. For WFC's Q2 accounts, 81% of average loans were funded out of its $318.4 billion in core deposits. (If you find reviewing a bank's financials to be difficult, check out Analyzing A Bank's Financial Statements.)

Final Thoughts

Morgan and Goldman will likely try to repeat the success JPMorgan and Wells Fargo have had with their deposit accounts. Where exactly the deposits will come from for the former investment banks is hard to discern. What is clear is that the former investment banks that were subject to less oversight in the past will be held to higher accountability standards in the near future.

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