Brokered Deposits, Where is the Big Bad Wolf

Reuters published an article last week on the “evils” of brokered deposits. And now my gloves are off!

Let’s get something straight. Deposits, brokered or otherwise are not the problem. The banks making poor management decisions are the problem. The problem is with the bank’s bad loans and poor investment decisions. It is not the accepting of brokered deposits that causes banks to fail.

The perceived problem with brokered deposits is that they are more volatile than a bank’s “core” deposits. This may have been true in the Stone Age when we didn’t have newspapers and the internet, but it simply IS NOT TRUE in 2008. In a matter of hours, a bank through the internet can take in Millions of dollars. Just look at the recent onslaught of funds that AARP helped Huntington National Bank raise or how about Countrywide Bank? Those internet funds are as volatile (and “expensive” I might add) as any brokered deposit.

There is also another class of deposits that most people outside of the banking industry probably don’t even know about. They arrive from a rate listing service. Rate listing services actually have a specific exemption from being considered deposit brokers because they don’t “facilitate” the placement of the deposit. They just provide rates and the investment manager makes the decision as to which institution to place the deposit. (Don’t even get me started on this one). Again, a bank can list CD rates on these services and within hours raise Millions of dollars. Millions of dollars that are just as volatile as any brokered deposit.

The article written by John Poirier also uses scare tactics and a nice salting of misinformation to give the impression that brokered deposits are evil. Almost every paragraph could be rebutted. But then this post would be 10 pages long.

First, the article leads off with a statement about “cash hungry banks are in danger of failing” because of brokered deposits. The fact is that the banks are cash hungry because they made risky loans that aren’t being paid back. Secondly, they are cash hungry because they are losing “core” deposits to high yield savings accounts and checking accounts that are being offered on the internet.

Next the article states that brokered deposits have “fueled a spate of recent bank failures.” First, there have only been four failures this year. I wouldn’t classify that as a spate. Second, of the four banks, only ANB had a large amount of brokered deposits. Douglas NB had about 3.2% of their deposits listed as brokered and First Integrity had about 4%. Banks that do take brokered deposits usually limit them to no more than 10%.

One of the funnier misstatements is the fact that the author writes, “Brokered deposits are short-term deposits that often attract banks in remote areas to increase lending activity.” First, brokered deposits can be far from short-term. They can be anywhere from 90-Days out to 20-years. The term is really dependent on the market. Secondly, the article implies that it was the lure of brokered deposits that caused them to increase risky lending activity. However, usually the bank has already begun the lending activity and suddenly realizes they need more deposits to fund the loans. The increased risk the bank was willing to take (at least during the Housing bubble) was fueled by greed and the low cost of funds, not brokered deposits.

One of the few partially true statements is “Brokered deposits also usually offer higher rates than other bank products such as certificates of deposits…” The true part is often the rates are higher. However, as I stated above, they may be no higher than many internet specials. This author shows just how little time he took with his research. 99% of brokered deposits are certificates of deposits.

Are brokered deposits really more expensive though? If a bank that has $1 Billion deposits needs $5 Million dollars they can make a private offering to brokers without alerting their entire deposit base of these higher rates. So would you rather pay a higher rate on $5MM or $1BB? Moreover, brokered deposits tend to be in higher denominations which means much, much less paperwork and handling for the bank. They also tend to be from other financial institutions. This means the patriot act doesn’t apply and the bank doesn’t have to worry about OFAC violations. In the long run, brokered deposits cost the bank less. Finally, although a single deposit may be more volatile, the broker is usually able to replace any deposits that close and thus, brokered deposits become a stable funding source. They are certainly more stable than high-yielding savings accounts being offered across the internet that can be withdrawn at anytime.

The author goes on to infer that ANB was a small Arkansas bank. He makes it seem like the evil brokers took advantage of a small little bank. ANB Financial at the time of closing was over $2BB in assets. Most banks do not have over a billion dollars in assets. ANB was a large bank. The management of this bank did not have the wool pooled over their eyes. The brokers didn’t come to them as wolves in sheep’s clothing.

He states that the FDIC picked up the $214 million tab when ANB was taken over. Pulaski took over a large part of the deposits. As the closure process hasn’t been completed and ANB’s assets sold off, there is no way to know how much it will actually cost. But if you want to talk about cost, how about the Bear Stearns bailout or the billions and billions of dollars the Fed has pumped into the system. How much is that costing and how much of that are the banks using to continue their mismanagement practices.

Deposits from any source other than the local area should have more scrutiny, if any additional scrutiny is going to be placed. If a bank’s insurance premiums are increased for accepting brokered-deposits, the practice of utilizing rate listing services and offering internet specials will increase, thus skirting the intent of the original regulations (which is to make banks keep a watchful eye on their non-core deposits).

If you’ve gotten through all of above, who is really going to pay for higher oversight and or the higher premiums that have been suggested? You the saver. You the saver are the one that will pay with lower rates. You have already been hit hard with the Fed lowering rates over 3%. The FDIC should scrutinize the entire banking operation, including all sources of deposits and lending practices. The fact is in 2008, all deposits are volatile.

One funny side note. I looked at the deposit breakdown on ANB. And I discovered why they failed. As of 3/31, the FDIC reported that they had about $1.8BB in deposits. Of that, about $1.7BB was listed as core and about $1.5BB was listed as brokered. A deposit can’t both be core and brokered. I think ANB failed because they simply couldn’t add 1+1. :O)

If you are a bank and need some funding. Give us a call. We have a variety of methods and sources we can use to help you raise deposits. Visit our bank funding page.

Can I Reasonably Expect to Receive Funding and New Lines of Credit For My New Business?

Launching a new business involves careful planning and focus, including the search for financial backing in some cases.

One Entrepreneur recently asked: Can I reasonably expect to receive funding to hire a technology company to build the IT engine for my internet business?

For this question, Business Manager, Deanne Geile of Huntington Bank states, “if the expenses associated with the build out are reasonable and well documented as a fundamental part of the business plan, then some or all of those expenses may be eligible for financing.”

When also asked: How does a new business establish new lines of credit?

Geile stated, “New business owners should understand the basic principles of credit evaluation before trying to engage a lender in establishing a line of credit or any type of loan.”

These include the 5 C’s of credit.
All five principles must be considered, so that issues in any one area can be addressed or mitigated, if necessary.

1. Capacity- refers to how much debt a borrower can comfortably handle. The financing entity will want to understand the current indebtedness of the borrower(s) and the repayment terms of all existing debt to determine if capacity exists to service any additional debt.

2. Capital- refers to current available assets of the borrower, such as real estate, savings or investment that could be used to repay debt if income should be unavailable.

3. Collateral- refers to the asset(s) that can be entailed or sold if a borrower fails to repay the loan(s). Collateral can typically support only one piece of indebtedness.

4. Conditions- This is an overall evaluation of the conditions surrounding the loan, including general economic climate at the time the loan is requested and the general purpose of the loan.

5. Character- refers to how a person has handled past debt obligations. Financing institutions will rely on the borrower’s personal credit history to determine the borrower(s) ability to repay their debts.

Most companies need working capital and they must decide to either self-fund or obtain a line of credit. Lines of credit are particularly difficult loans to obtain for start-ups and small businesses primarily because of the lack of a prior credit history as the most important factor.

Be A Successful Entrepreneur:
To be successful, borrowers should:

Be very clear about the need for a line of credit.
For example, “we need working capital to fund payroll in advance of the collection of accounts receivables,” is a great explanation for a line of credit. Saying you want the line as a “cushion” or “safety net” is like telling the financing entity that the line is going to be used when things start to decline or go wrong.

Be accurate with your assessment of need.
Ask for an amount of money that is reasonable for your business. Asking for $100,000 when $25,000 for weekly payroll is all you need is a good indicator that you, the business owner, may not understand your cash flow.

Consider how much collateral will be needed to secure the line.
Keep in mind that most lenders do not advance 100% on any single type of collateral. Equipment and inventory are heavily discounted as collateral. If you want a $100,000 line of credit, be aware that you probably need about $150,000 to $200,000 in collateral.

Start small.
Lenders are more likely to start small and then help you grow into a line as your business expands. SBA guaranteed lines of credit are also available through approved lenders. Any program that takes some of the risk off the lender will be an advantage. The SBA 7(a) program provides for up to $350,000 for working capital lines.

Whether your question is about obtaining funding or generating revenue, one this is certain: preparation, planning and focus are critical to any start-up.

What Are My Options For a New Business Loan?

With some estimates of nearly 500,000 new businesses started each month, business owners have many questions about microlending and other financing options.

According to Business Manager, Deanne Geile of Huntington Bank in Michigan, new business owners should consider contacting the Small Business Administration Microloan Program that provides loans for start-up capital or small businesses with growth issues. Funds are available through intermediaries, a non-profit community based lender, in amounts up to $35,000 with the loan size averaging approximately $13,000.

According to Geile, loan applications and all credit decisions are made through the intermediaries at the local level. The SBA website has a list of all intermediaries.

In addition to banks, there are a number of alternative lending sources to consider. One alternative might be a venture capital firm.

Venture capital (also known as VC or Venture) is a type of private equity capital early-stage, start-ups and established companies with high growth potential due to innovation.

VC firms typically make cash investments in exchange for shares in the invested company. In exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company’s ownership (and consequently value).

There are pros and cons to engaging in this kind of arrangement, from the pros of getting money that enables you to expand your market share before someone else does to the con of no longer being the sole owner of your company. Successful entrepreneurs will want to do their homework before engaging this option.
Some first-step actions that entrepreneurs might consider taking include:

o Explore grant programs through the local municipality where you plan to set up business. In Michigan, the Michigan Economic Development Corporation (www.themedc.org) provides significant information to help new entrepreneurs in funding.

o Get involved with the local chamber of commerce programs. These groups are designed with the specific purpose of promoting local businesses, with an eye on seeing these businesses reach their maximum potential. The Canton Chamber of Commerce located in Canton, Michigan set up a volunteer (and free) Mentor/Protégé designed specifically for new business owners. For additional information on this program, visit their website at http://www.cantonchamber.com.

o Join the Small Business Administration. Take advantage of all their programs from business planning to funding options. Most of the programs SBA offers are free. They provide valuable information for the entrepreneur.

It is important for any new entrepreneur to do their home to determine the best option for the long-term viability of their business.