Like most community banks, Union National Community Bank in Mount Joy, Pa., is constantly on the lookout for low-cost funding.
The $410 million-asset bank's latest source: selling two- and three-year certificates of deposit to limited liability companies formed solely to make a market for these CDs.
"This allows community banks access to a much larger marketplace without having to compete with the local CD specials that other banks are offering," said Dwight N. Kreiser, Union's vice president and chief accounting officer.
The bank plans to make its first sales next month with the help of Index Powered Financial Services, a Denver wholesale CD broker that is creating these LLCs.
Here's how it would work:
Each LLC would purchase from at least 100 community banks a $100,000 CD, insured by the Federal Deposit Insurance Corp., at below-market rates. Using as collateral this pool of CDs, the LLCs would then sell AAA-rated notes to institutional investors, which would earn returns typically 63 to 68 basis points above U.S. Treasury notes.
"Once investors figure out that it's a way to decent returns from something backed by FDIC-insured deposits," Mr. Kreiser said, the CDs will "be a new funding source at a reasonable cost ."
Bob Cowvin, Index's president and chief executive, said it is trying to sell an institutional buyer the first note created through the program: a medium-term note at 4.15% backed by $9.95 million in CDs from 102 community banks.
The concept is unproved, but Mr. Cowvin predicts the product will catch on. "This may be the only AAA-rated note offered by a private company," he said.
For years community banks have been able to sell longer-term CDs to wholesale brokers that offer them to investors. But investors have been limited in the number of FDIC-insured CDs they could acquire from one bank.
Under Index's so-called Capital Market CD program, investors can purchase notes from an unlimited number of LLCs. Each note would be collateralized by CDs, conceivably from the same banks.
All of the CDs remain FDIC-insured, because each LLC can buy only one, valued at up to $100,000 including accrued interest, from each bank.
Index is hoping the program becomes popular enough on Wall Street to eventually enable it to form LLCs every day, Mr. Cowvin said. This would give community banks another steady source of low-cost funds.
Hillcrest Bank in Overland Park, Kan., is interested.
"Loan demand is very high right now, as the commercial real estate market in the Kansas City area is extremely active, and it's good to have a diversified source of liquidity," said G. Richard Degen, an executive vice president and chief financial officer of the $1.1 billion-asset bank.
Another firm, Insured Deposits Conduit LLC in Miami, is trying to launch a similar program, said Jorge H. Coloma, its managing director.
Initial plans call for forming 10 to 20 LLCs that would issue notes collectively backed by $200 million in CDs from community banks. Mr. Coloma said his company would like to eventually form that many LLCs each week.
Since 2003 banks have been able to hold more than $100,000 in CDs for single investors using a program developed by Promontory Interfinancial Network in Arlington, Va.
But under Promontory's Certificate of Deposit Account Registry Service, investors are limited to buying $20 million in CDs from any one bank. (Promontory disperses the deposits to a number of banks so that no bank is holding more than $100,000.)
Under the program Index is creating, banks could hold an unlimited number of CDs that back various notes bought by a single investor, because the LLCs retain ownership of the CDs.
Though investors buy CDs in Promontory's program, Index is effectively offering a way to securitize CDs through the issuance of notes.
