Adam Dean, President of SVB Asset Management writes about "The Trouble with CDs (2010 edition)" in the latest edition of the firm's "Observation Deck newsletter. Dean asks, "What's a securities broker to do? The boards and CFOs that have employed them to manage corporate cash have largely and perhaps permanently lost all appetite for the products that were once so lucrative for brokers to sell. Auction rate securities, self-underwritten debt, investments with low liquidity and high underlying risk; because of the pain these investments caused their corporate clients and boards, the broker business isn't nearly what it used to be."
He continues, "Corporations now demand extremely liquid and ultra-safe investments such as money funds, agencies and treasuries, and frankly, those don't pay brokers much. Enter the non-negotiable Certificate of Deposit and CD placement programs. For corporations looking for safety and yet hungry for yield, CDs sounded like the best of both worlds. Today that yield benefit is largely gone."
Dean explains, "Central to the selling of non-negotiable CDs (meaning they cannot be liquidated prior to maturity without penalty) and CD placement programs is the considerable payout brokers get relative to other standard money market options they could offer their clients. In other words, if you are interested only in government-backed investments, there is at least one reason you may be hearing about a CD-only investment strategy instead of a diversified treasury, agency and money fund strategy that leverages a credit research team and fiduciary oversight."
He says, "The other reason you may have heard of them was yield. What CDs and CD placement programs used to have relative to more liquid investments was yield. This despite the fact that the unrated regional and community banks that typically use broker sales channels like CD placement programs comprise the majority of the 220 bank failures observed since 2008 and the 57 that have occurred so far in 2010."
But now, the Observation Deck piece explains, "There are two reasons for lower CD rates. One is that the FDIC has moved to cap the yields that banks can offer on FDIC-guaranteed CDs. A number of banks were essentially staying in business by offering CD rates well above market.... The second reason is driven by better-capitalized banks. Yields are down across the board because government-guaranteed safety is not something that most banks need to offer much yield on to attract depositors. Their market-setting rate pushes down the yield that deposit-hungry banks can offer."
It continues, "With the yield benefit largely gone, very little else about non-negotiable CDs meets the liquidity, transparency and credit standards required of every other investment typically allowed in a conservative cash investment policy. For corporations allowing investment in CDs, make sure your investment policy clarifies the terms on which you are willing to buy them. If you are making exceptions to the liquidity, transparency and credit standards you require of each your other investments, make sure you are stating this in your investment policy."
Finally, Dean warns, "The higher-yield CD offerings are almost exclusively non-negotiable. Every security type permitted in your corporate investment policy should include the ability to easily sell back into an open market on demand and without incurring an early withdrawal penalty prior to maturity. Non-negotiable CDs don't meet this standard.... Knowing the condition of the bank you are making the loan to should be mandatory for a corporation. With CD placement programs, individually brokered CDs, or even direct investment in CDs from regional banks, an ability to accurately assess their health requires a considerable investment in time that the selling broker has almost certainly not done for you.... If a certain CD is yielding well above market, ignore the FDIC insurance for a moment and look at the bank's actual credit rating."
