By Daniel Denekamp, Vice President, HOA Division, U.S. Bank
s the list of ailing financial institutions grows longer each day and the probability of future bank failures becomes likely, more and more Community Association board members are wisely becoming increasingly concerned. For many, the past priority placed on rate of return has given way to principal protection and the need for more due diligence. Unfortunately, unlike comparing investment rates, evaluating the health of your financial institution and assessing the principal protections they offer requires much more homework.
The first step to ensure your Association’s dollars are safe is to clearly understand the government protections already in place. Most of us are familiar with the Federal Depository Insurance Corporation, better known as the FDIC, and the $100,000 layer of protection provided to customers of a bank. And while the FDIC program has a great history of success, a common misconception is that the $100,000 protection is applied per bank account. In actuality, the coverage is limited to $100,000 of protection per bank determined by Federal Tax I.D. number.
A second source of protection is the SIPC, or Security Investor Protection Corporation, established to protect assets held at brokerage firms. The SIPC is often thought to be the equivalent of the FDIC. While the SIPC does protect cash and cash equivalents up to $100,000 (up to $500,000 for other securities), great differences exist. While the FDIC actually insures your deposits and is able to pay a claim, the SIPC’s primary objective is to return securities to investors in the event a broker-dealer becomes insolvent. This can be a lengthy process, and the SIPC does not protect the investor from market fluctuations.
Once you understand the government sponsored protections, the next step is to make sure you never need them. This requires you to investigate the financial strength of your bank. One of the simplest ways to evaluate your financial institution can be found at Bankrate.com®. Bankrate® offers a plethora of information about banking and has created a proprietary system to measure the strength of banks. The system measures capital adequacy, asset quality, profitability, and liquidity and produces a simple star rating and number score. This rating tool can be found at http://www.bankrate.com/brm/safesound/ss_home.asp . Other rating firms like Fitch®, Dun & Bradstreet®, Standard & Poor’s®, and Moody’s® also analyze the financial health of banks and Brokerage firms. However, with the exception of some basic rating reports offered by Fitch®, most information is offered at a fee.
In addition to the FDIC, several other government agencies monitor the banking industry. These include the Office of the Comptroller of the Currency and the Federal Reserve. Each agency provides a valuable website; however, in an attempt to help consumers better understand the financial condition of their bank, an interagency body known as the Federal Financial Institutions Examination Council or FFIEC, was created.
The FFIEC operates the Central Data Repository or CDR (https://cdr.ffiec.gov/public/) database. Because this database collects financial information about most banks, it is one of the best tools for analyzing the financial strength of your bank. In searching the database, it is important that you know the Chartered name of your bank. If your bank operates under a DBA or “doing business as,” you may have to contact the bank and request the Charter name. After finding the bank, two of the most important reports you will need to review are the Income Statement and Balance Sheet. Together they can quickly show you if your bank is profitable and managing its assets properly. If you are uncomfortable reading them, share them with the Association’s Accountant. To further your due diligence, the FFIEC also provides what is known as Uniform Bank Performance Reports or UBPR. While extensive in nature and probably best interpreted by an accountant, they do provide several years of side-by-side history that can help you confirm positive or negative trends.
Once you are confident in your bank, the next step is selecting the investments and the type of programs offered to protect them. For most Associations this means a combination of money market accounts and/or Certificates of Deposit.
Because most Associations have bylaws requiring all deposits be insured, many Associations resort to opening accounts at different banks to secure FDIC insurance. This, however can be cumbersome and time consuming. To solve this dilemma, some banks offer additional insurance coverage for deposits in excess of FDIC. This protection tool can be an excellent way to consolidate banks and allows you to leverage your total deposit base to get special pricing and services. If your bank offers this type of program, be sure to inquire about specifics and obtain a copy of the insurance binder or surety bond.
To accommodate large dollar purchases of CDs, most large banks offer in-house investment services. Because these investment services can purchase investments from multiple banks and brokerage firms, the portfolio can be structured so that FDIC/SIPC insurance coverage is in place for each individual security. Some banks tailor these services to meet the needs of Community Associations. These custom services typically include a consolidated statement showing both individual and blended yields, maturity dates, and the investment grade of the securities. They may also include notification and advice when a security matures. This advice should incorporate the Association’s reserve study to ensure the portfolio matches the risk, return, and liquidity needs of the Association. To accomplish this, an investment advisor often builds an investment ladder of CDs purchased with various yields and maturity dates.
For smaller banks, many belong to the Certificate of Deposit Registry Service, or CDARS www.cdars.com. The CDARS program allows a member bank to purchase up to $50 million in CDs for any one customer while making certain they are covered by FDIC insurance. To accomplish this, the purchasing bank utilizes the CDARS network to find matching CDs offered by nearly 1900 member banks. The system then purchases individual CDs at each of the matching banks in increments less than $100,000, thus ensuring FDIC coverage is achieved for both principal and interest.
While the process of evaluating your bank and investment choices can be very time-consuming, these efforts will greatly enhance your financial decision making skills. Additionally, this exercise will help you fulfill your fiduciary duties on behalf of your Community Association.