When discussing UMB Bank’s balance sheet, our CFO, Ram Shankar often refers to deposits as the bank’s raw materials. Just like lumber is to a home builder, deposits are an essential ingredient to making loans and operating a healthy bank. The historic rise in interest rates have caused bank’s raw materials costs to skyrocket. We are competing with not only other financial institutions, but with money market funds and the treasury market. This dynamic has caused banks (and regulators) to take a much harder look at liquidity management.
UMB has been busy helping our clients source these precious raw materials through the brokered CD market. This article discusses and gives an overview of the brokered CD market, issuance process, and dispels old stereotypes.
Brokered CDs: Why the bad rap?
Whether deserving or not, brokered deposits have often carried a negative connotation. They tend to be mischaracterized as “hot money.” It is true there have been correlations between high levels of brokered deposits and bank failures, especially in the wake of the 2008 financial crisis. Because brokered deposits do not require collateral, banks chasing fast growth used brokered funding to leverage their capital. In several cases, this quick pace of growth ended up resulting in poor credit decisions. In the end, it was credit quality that caused the failures, not the use of brokered deposits.
As with all things in life, we attempt to learn from our mistakes. Regulatory bodies have adapted, stepping up credit monitoring, capital requirements, and liquidity, including monitoring for high concentrations in brokered funding. They have also tamped down the de novo bank landscape, making it much more difficult to start a new bank.
What about the “hot money” label? Hot money usually refers to deposits chasing the top rate available, with no regard to the overall relationship. These funds are usually the first to leave whenever a better offer presents itself. Brokered CDs, on the other hand, are funds gathered in a very efficient market. Once issued, these funds cannot leave the bank without paying an early redemption penalty. Rather, the owner of a brokered CD must sell their position to get access to their funds. This offers deposit stability to the issuing bank not available in other funding accounts. In addition, when used prudently within a defined set of policies and procedures, they are a great tool to complement your balance sheet.
The other concern we often hear is that regulators do not like brokered deposits. While this can be true in situations of heavy concentrations, it is mostly over-stated. In-fact, the Interagency Policy Statement on funding and liquidity risk management issued July 28, 2023, encourages banks to “maintain a broad range of funding sources” as a part of their Contingency Funding Plan. Regulators consistently suggest testing these sources, including the brokered CD market. Overall, if brokered deposits are included in your liquidity and contingency funding plans and used in moderation, they should not draw unwanted scrutiny from regulators.
Benefits of brokered deposits
Non-redeemable: It is a bit ironic that brokered CDs often come with a stigma of “hot money” when in fact they cannot be redeemed early (except by you, in the case of a callable option). Owners of CDs issued by your bank must be redeemed in the secondary market.
From an asset/liability perspective, brokered CDs allow you to structure maturities according to your bank’s cashflow needs and rate sensitivity in a distinctly predictable fashion. Hot money can take several forms, but brokered deposits are looking less and less hot as many banks look to supplement their funding needs with the stability and predictability of brokered funding.
No collateral required: Banks have lots of levers to pull when it comes to secondary liquidity sources. This includes the Federal Home Loan Bank and the Fed’s new Bank Term Funding Program (BTFP) which allows you to borrow at par value for underwater securities. Both are important sources but require collateral.
An attractive benefit of Brokered CDs is that they do not require collateral. Supplementing liquidity using a prudent number of brokered deposits allows you to keep other collateral available. In other words, holding onto some dry powder. This enhances your banks contingency funding plan.
Rate: The inverted yield curve has made for a challenging operating environment for banks. If this environment lasts until spring of 2024, it will be the longest period of curve inversion on record. It is also looking more and more likely. However, we can use this to our advantage with term borrowings being cheaper than overnight. Adding a small amount of tenor to your liabilities can help save interest expense and protect against the potential of rates increasing further.
Flexible terms (callables): While there is a debate on timing, rates are generally expected to fall at some point in the future. We can offer issuers the ability to structure CDs with a call option. While there is a pay up for this option, this is an attractive benefit should rates eventually retrace lower. While the offering rate may need to be higher to attract buyers, typically the underwriting fee does not increase on a callable issue.
Control the volume you raise (committed issuance): UMB works with Fidelity to issue brokered CDs and is one of the key differentiators in UMB’s offering. This partnership allows us to tap into Fidelity’s vast distribution network and sizeable balance sheet. As a result, we can offer funding commitments at a minimal pay-up to a best-efforts offering. Having a concrete idea of your funding volumes removes much of the stress and uncertainty from your funding plan.
Raise funds outside of physical market: Local CD specials often draw attention from the wrong crowd –current depositors! This can often lead to an increased costs of funds and less new money than you hoped. The brokered CD market allows you to access funding outside your market so that you can avoid driving up costs within your own market. You can also put restrictions on your issuance to make sure it is only an option outside of your footprint.
One of the biggest attractions to a brokered CD program is how quick and efficient the issuing process is. New and existing customers can get access to funds in as little as a week from issuance to settlement date. Once you have decided the amounts and terms that work best for your balance sheet, the process requires very little work from your team.
All CDs are issued on either a “committed” or “best effort” level. Just like the bond market, pricing in the brokered CD market adjusts based on supply and demand. Committed levels will get you the amount of money you need at a set level. Best effort levels will be at a slightly lower rate, with our underwriting group making a best effort to get your order filled at those levels. There are only two forms to fill out, a terms agreement and a brokerage agreement. For a small underwriting fee of 10-15 basis points, we will handle all the marketing of your brokered deposit campaign. That way your team can keep taking care of your customers.
How we’re meeting customer needs
Through Fidelity, UMB can provide access to an efficient source of funding to help with your liquidity needs. In 2022, we issued more than $4.7 billion in 137 different CD terms. This year, we have more than doubled last year’s total, issuing 279 different CD terms and more than $10 billion year-to-date. Each Monday we update CD issuance rates.
Liquidity and funding continue to be the top topic in all our conversations with our customers, so we don’t expect demand to slow down. Brokered CDs offer another option for your liquidity and contingency funding plans. When used properly, they can help you maximize your earnings, efficiency ratio and growth.
About the authors:
Francis Scheuerman is senior vice president and investment officer at UMB Bank, n.a. Capital Markets Division. He offers transaction and portfolios services for banks, institutions, and financial advisors throughout the Midwest.
John Kilroy is senior vice president and investment officer at UMB Bank, n.a. Capital Markets Division. He offers transaction and portfolios services for banks, institutions, and financial advisors throughout the Midwest.
James Carlile is an investment officer at UMB Bank, n.a. Capital Markets Division. He is responsible for helping institutional clients understand how to best manage their bond portfolios and interest rate risk.
The first step in the process is speaking with your UMB representative about what the best option is for your bank. Learn how UMB Bank Capital Markets Division’s fixed income sales and trading solutions can support your bank or organization, or contact us to be connected with a team member.
This communication is provided for informational purposes only. UMB Bank, n.a. and UMB Financial Corporation are not liable for any errors, omissions, or misstatements. This is not an offer or solicitation for the purchase or sale of any financial instrument, nor a solicitation to participate in any trading strategy, nor an official confirmation of any transaction. The information is believed to be reliable, but we do not warrant its completeness or accuracy. Past performance is no indication of future results. The numbers cited are for illustrative purposes only. UMB Financial Corporation, its affiliates, and its employees are not in the business of providing tax or legal advice. Any materials or tax‐related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor. The opinions expressed herein are those of the author and do not necessarily represent the opinions of UMB Bank or UMB Financial Corporation.
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