Publications & Resources

January/February 2009
Focus: Funding & Liquidity

The Regulatory Outlook for Brokered Deposits

By Susan Murphy

In October, the FDIC proposed increasing insurance premiums to stem the flow out of the insurance fund. By the time of this publication, this will have been finalized.

Two issues in the proposal beg for comment: increased premiums for brokered deposits and the definition of brokered versus non-brokered funds. The brokered definition has been problematic since the S&L Crisis in 1989. 

Increased Premiums
The FDIC is considering imposing additional premiums on institutions that hold a certain percentage of their assets in brokered deposits: “Generally speaking, the greater an institution's asset growth and the greater its percentage of brokered deposits, the greater would be the increase in its initial base assessment rate.”

What's driving the FDIC in part is the belief that brokered deposits decrease the franchise value of a bank, which few would debate. The same is true for CDARS or FHLB Advances. There is concern that brokered deposits might expose banks to risky funding. However, the FDIC said in its Spring 2005 Release: “If properly administered, such diversification of funding sources can benefit FDIC-insured institutions…many institutions have found that brokered deposits can be a more cost-effective deposit-gathering mechanism than building new branches.” 

Non-core funding plays an important role in funding, and in liquidity policies. Brokered CDs are useful for institutions' contingent liability plans, acknowledged by the FDIC this past August, when it said in part that banks “…should have realistic contingency funding plans that are responsive to changes in liquidity risk exposure.” In 2008, many examiners encouraged banks that had not previously tapped the brokered market to put brokered CD relationships in place for contingent liability purposes. This is something we have not seen in 24 years.  

Definition of Brokered vs Non-Brokered Funds
The FDIC is asking whether brokered deposits that consist of sweep balances should be excluded from the definition and whether “brokered” should exclude CDARS-type reciprocal deposit arrangements. Brokerage firms, for their part, might benefit if MMDA sweep accounts were separated from the “brokered” classification because MMDA is believed to be more than half of what is reported to the FDIC as brokered monies, thus avoiding the extra FDIC premium.

From the standpoint of a bank's funding strategy, MMDA is overnight money while CDs can be relied upon longer term. When liquidity is challenging, brokered CDs help offset the effects of irrational runs on institutions, providing a measure of stability. In addition, brokered CDs can be raised quickly in bulk for specific terms without cannibalizing existing core deposits CD specials, and without having to compete with local institutions offering high rate specials. If an institution is well capitalized, the brokered market is effective and price competitive, as are CDARS and FHLB Advances. A more transparent and even-handed definition would be uncollateralized non-core funding.

It would greatly benefit banks if broader perspective were injected into the discussion:  core versus non-core funding definitions would provide clarity. Perhaps inject a ratio of core versus non-core funding before applying insurance premiums. The spreads between funding alternatives without bias would allow a bank to tap the most cost effective funding sources without penalty. Diversification of non-core funding sources is prudent:  FHLB advances, brokered deposits, CDARS…these all play a responsible role in funding for all banks. By imposing a higher premium for non-collateralized non-core funding, the premiums would be far less onerous.

Brokered CDs have been referred to as Hot Money. What is hot money? We receive calls from bankers anxious to replace maturing Public Funds CDs, which are typically in the millions, and can depart without notice. Recently, major banks have been offering local rates that are up to 75 basis points higher than the cost of brokered deposits or CDARS; Public Funds CDs have lower rates but come and go; MMDAs are demand deposits.

Conclusion
Increased insurance premiums may be inevitable, but the proposed rule is problematic. And while the insurance fund must be recapitalized, it seems the FDIC is pressing premium increases on the industry at a time when it can least afford them.

By the time of this publication, the conclusion will be known and new premiums likely imposed. If we failed to accomplish core versus non-core funding definitions this time, we suspect the issue will come up again as it has not yet found its logical conclusion.

Susan Murphy is a managing director at Morgan Keegan, & Co, Inc. in the Fixed Income Capital Markets CD Department. She can be reached at 800-628-6664 or sue.murphy@morgankeegan.com.

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