Sign Of A Problem Bank – High CD Rates

Brokered Deposits Keep Problem Banks Alive

Citizens National Bank, Macomb, Illinois, was the latest failed bank on May 22, 2009.   One eye-catching statistic on this bank failure was the stunning percentage of Citizens assets represented by brokered deposits.   Of total deposits of $400 million, a whopping 50% ($200 million) represented brokered deposits.

Many problem banks remain in business by attracting funding through brokered deposits that offer interest rates far in excess of prevailing rates. The higher interest rates are necessary to replace funds withdrawn by large depositors concerned with a problem bank’s weak financial position. The brokered deposits are typically sold as “risk free – FDIC guaranteed” certificates of deposit (CD) in amounts up to FDIC deposit protection limits.

Brokered deposits have also been associated with banks that fueled very rapid growth in high risk loans funded by high yielding brokered CD’s.  Critics have argued that brokered deposits allows banks to substantially increase risking lending and also allows problem banks to stay in business long after they should have been closed. The net result of allowing problem banks to obtain high cost funding through brokered deposits is an increased cost to the US taxpayer when the problem bank subsequently fails.

Problem Banks Pay The Highest CD Rates

An easy way to know if a bank is in trouble is to compare their CD rates with the national average.  A CD rate significantly above the national average usually indicates a troubled bank.  Many problem banks have stayed open only by selling high rate CD’s through brokers.

Due to the extreme banking crisis of the past few years, the FDIC had no choice but to allow brokered deposits in order to avoid the insolvency of a large number of banks that the FDIC was unprepared to handle.   In addition, during the initial stages of the banking crisis, many analysts did not comprehend how much worse the situation would become.  To the FDIC’s credit, they recently imposed rate restrictions on brokered deposits if a bank is not “well capitalized”.

Corus Bankshares Pays 3rd Highest CD Rates

The extent to which problem banks rely upon high cost brokered deposits is explained by Corus Bankshares in their March 31, 2009 10-Q filed with the SEC.

The Bank must comply with federal restrictions on the interest rates the Bank may offer to its depositors. Under these restrictions, the Bank cannot pay interest rates higher than 75 basis points above the national average rates for each deposit type. This restriction is potentially significant to the Bank due to its historical practice of paying above average rates both locally and nationally.

As an alternative, Corus decided that offering above average rates nationally, promoted via the internet, was the most efficient and cost effective strategy for the Bank.

Corus submitted a plan to the FDIC that presented the Bank’s normal market area as the national market. The FDIC approved our national market designation and our use of the Bankrate.com average national rate table to determine the base rate.

On January 27, 2009, a new rule was proposed by the FDIC that would amend its existing rules which impose interest rate restrictions on deposits that can be paid by depository institutions that are not “wellcapitalized.”  Under this new rule, affected depository institutions would be allowed to pay a “national rate” plus 75 basis points, and the FDIC would set and publish the national rate.

The FDIC limits on rates that problem banks can offer depositors was long overdue.  The reason that banks such as Corus had a “historical practice of paying above average rates” is because large depositors recognized that Corus was engaged in high risk lending and withdrew funds above the FDIC guaranteed deposit limits.  To bring in new money, Corus had to pay high CD rates.

A quick check of CD rates on bankrate.com reveals that Corus Bankshares is paying the third highest CD rates of any bank.   Given the very serious financial difficulties at Corus Bankshares, as discussed by management in their latest Form 10-Q filing, do not expect the high CD rates from Corus to be available for much longer.

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