Since American Banker published the front-page article "Small Banks Leaning More on Brokered Deposits" on Oct. 3, a number of my community banker friends have asked for more details about using this technique to solve the critical task of funding loan demand.
As the article pointed out, the use of brokered deposits is burgeoning among community banks as well as large ones. Since 1997 the amount of brokered deposits held by banks with under $1 billion of assets has risen 106%, to $12.8 billion on June 30.
Brokered deposits earned a bad reputation in the late 1980s by enabling poorly capitalized and managed savings and loans to obtain billions of dollars to put in questionable development projects and junk bonds.
As the article pointed out, the regulators are keeping a close watch on institutions that use money brokers. After all, if these institutions fail, the Federal Deposit Insurance Corp. and the taxpayers must make up the losses.
I spoke with William Miller, senior vice president at the Ryan, Beck & Co. investment firm in Livingston, N.J., about its promotion of brokered deposits. He pointed out that:
- Of the 8,539 banks and thrifts with assets under $10 billion, 836 (just under 10%) have brokered deposits as part of their liability structure.
- In that subset the average ratio of brokered deposit to total liabilities is 6.95%.
- The average asset size of these institutions is $338 million.
- Their average loan-to-deposit ratio is 86.2%.
How does Ryan Beck go about its work as a money broker?First of all, its legal advisers make sure that the brokered deposits it sells are structured so that each investor is buying an asset of under $100,000, fully insured by the Federal Deposit Insurance Corp.
Then it can buy the certificates of deposit outright as a dealer, in turn selling them to other institutions in need of quality investment paper for their customers.
Obviously the banks have to offer a rate somewhat higher than that on retail CDs sold locally. They could also pay the somewhat higher rate for Federal Home Loan Bank advances, but that requires pledging collateral, which a business-oriented bank may find difficult to provide.
Mr. Miller said that on request he can guarantee that a bank's CDs will not be sold in its home state. That means the bank can pay extra to raise money away from home without worrying that it is, unwittingly, just paying extra for local money.
A money broker can also arrange a CD with a longer term than a bank might be able to place locally. In this way the bank can draw in money without worrying about its leaving as soon as someone in the community offers a few more basis points.
Brokers are also developing an equity-linked CD, which would pay the depositor a yield related to a specific stock market index. In this way the bank could tap the market of investors who want equity investments rather than fixed income. In these days of deregulation, when they are looking to sell brokerage services and insurance as well as traditional products, banks want to work with just this type of investor.
Mr. Nadler, an American Banker contributing editor, is professor of finance at Rutgers University Graduate School of Management.