Many banks only insuring $250k again

Why enterpreneurs (and investors) should care

Financial trends and news by Lorenzo Carver
December 7, 2009
Short URL: http://vator.tv/n/c39

The FDIC extended the protection of non-interest bearing accounts beyond the $250,000 limit for another six months (now ending June 2010 instead of January 1).  However, with new fees (from 50% to 150% higher depending on the riskiness of the bank taking the insurance for its customer deposits), banks were given until early last month to "opt-out" of the extended protection.  Many of the largest banks such as Citibank (NYSE symbol: C), JPMorgan Chase (NYSE symbol: JPM), Bank of America (NYSE symbol: BK) and Wells Fargo (NYSE symbol: WFC) opted out.

Why should entrepreneurs and investors care about this?  To get a perspective, I've copied one response I wrote to investor concerns about the security of their cash in banks of companies they considered investing in.  Other friends closing deals during the same time period were dealing with the same types of concerns from sophisticated investors.  Given the financial collapse, and the inability of many to get cash out of so-called "cash equivalents" that same year, the concern was not entirely without merit.   

My friend, and client, Mark Freedle of NetMore America raised around $9.5 million in equity for his mortgage bank right after the mortgage industry started collapsing.  He was ultimately able to turn that $9.5 million into over $1 billion in leverage, which he used to buy and resale government backed securities at a profit.  However, when Lehman, Merrill Lynch, Wachovia and others started shaking, so did prospective investors.  Some of the questions they were asking last year this time don't even come up in discussions anymore.  One of those questions was "What Happens To My Cash If The Bank You Put It In Fails?"  I haven't heard that question in any deals lately.

This, along with FDIC insurance increases, may explain why many banks are pulling  out of the Temporary Liquidity Guarantee Program's "Transaction Account Gaurantee" or TAG, which basically offered unlimited protection to non-interest bearing accounts. 

Here's a summary of my response to one of those investors (from last year), used with Mark's permission of course. Incidentally, 100% of what I suggested did in fact take place.

Responses to macroeconomic concerns, from January 2009.

We believe the essence of the remaining macroeconomic concerns you've expressed can be reduced to a single question: "How do we know our cash is safe if a bank fails?

The simple answer is that the cash will be held in a manner that insures 100% coverage by the FDIC.

Non-interest bearing Business Demand Deposit Accounts (DDA) are currently 100% insured (through December of 2009 without limit to dollar amount. Details on how this protection and a number of alternatives address your question of cash risk follow beginning on the second page of this response.  Points are in outline format and many items are hyperlinked to source documents from issuing or otherwise authoritative entities.

Hypothetical Wells Fargo insolvencyPOTHETICAL WELLS FARGO INSOLVENCY:

1. Non-interest bearing Business Demand Deposit Accounts (DDA) are currently 100% insured (through December of 2009) up to essentially an unlimited amount through the FDIC

a. Applies to non-interest bearing DDAs

b. The bank pays 0.10 basis points on amounts over the $250,000 FDIC coverage for interest deposits for participation

c. The program is termed Temporary Liquidity Guarantee Program

d. Here's a link to a copy of the testimony

2. If, after 2009...

a. The transaction program is not extended and b. There remains concern for solvency of the very largest banks c. Or, the investors believe that unused cash should be earning some kind of return:

I. Then taking advantage of Cedars (CDARS) with a regional or other bank in the program (2.5K+), is a good option

II. Currently $50MM in Certificates of Deposits can essentially get FDIC coverage through this scheme

1. There's a setup cost plus some maintenance fees, obviously offset by interest yield. So banks will often eat the setup costs since they are getting large timed deposits

3. Impact of unemployment on bank solvency

a. Loan losses would be more sensitive to the Unemployment Insurance exhaustion rate than they would be to a net increase in the unemployment rate

b. Unemployment benefits were already extended by 50% as part of the Iraq spending bill (from 26 weeks to 39, so 3/4th of a year)

c. Those benefits were extended by another 20%, or 7 weeks, with legislation in October/November of 2008.

I. The same congress that passed that legislation is quick to use it (benefit extension) as a shield for social reasons

II. More importantly, most economists agree that the proportion of long-term employed currently gives extension of benefits a greater economic impact (1.64X or so in GDP for every $1 in additional benefits)

Bank common trading prices as cessation trigger:

4. As noted above, your cash in DDAs is 100% insured by the FDIC (it was not 12 months ago, unless you were using Cedars with a regional)

5. That's better assurance than some kind of stock based trigger (full faith and credit assurance versus failing bank admin assurance and simultaneous collapse of investment vehicle)

6. Downgrade of their debt is also not trigger

a. Inability to insure the funds up to the maximum amount held, should be a trigger to transfer to a Cedar account or otherwise change trust names on accounts in an effort to regain 100% FDIC insurance coverage

b. Insurance risk is not an issue until December of 2009

7. That (unlimited insurance on cash deposits, + guarantees on mortgages) makes this the best time in history to do this type of deal

a. Your cash is insured at max cost to the investee of 0.10 basis points

b. If it was in cash DDA, you would have a negative return

c. With the coupon, you are getting the best of both worlds

Opinions expressed herein by Lorenzo Carver, do not necessarily reflect the opinions or views of Liquid Scenarios (bpCentral, Inc.) http://www.liquidscenarios.com/

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