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There’s More To Lose When The Bank Holding Your Brokered CD Fails

When I first considered investing in brokered CDs, I wasn’t surprised to learn that FDIC insurance could present complications.

The agency says certificates of deposit held by a broker on a customer’s behalf are considered owned by that customer, not the broker.

This means, according to standard CD disclosures, the customer is entitled to $250,000 in insurance for the CD and other deposits held in the same “insurable capacity” at a bank.

In other words, if the bank fails, brokered CDs will be combined with other CD and deposit accounts established by the customer directly at the bank to determine coverage.

I’ve opened personal CDs in three “capacities” at banks — individual, individual with payable-on-death beneficiary and individual IRA.

I can replicate this at a broker by opening separate individual, transfer-on-death and IRA accounts, buying brokered CDs for each account.

If the bank fails, FDIC insurance applies to my accounts at both institutions, but I have to add what I’m owed in my direct accounts at the bank with what I’m owed on its brokered CDs held in like capacity in my brokerage accounts.

If the combined amount exceeds what I’m entitled to for accounts in that capacity, I’m uninsured for the excess.

Further complications arise in bank failures.

First, if the FDIC finds another institution to buy the failed bank’s assets and assume its deposits, brokered CDs will probably be spurned by the buyer, left behind to be paid by insurance.

According to a 2011 FDIC report, brokered CDs lack “franchise value” in acquisitions.

That’s because they don’t represent a relationship with an actual customer and are more likely to represent “hot money” — funds from investors actively seeking short-term returns — than CDs opened directly.

As a result, when the bank fails, you’ll probably be paid off before maturity, losing the benefit of the interest rate you have.

And you’ll have to wait for your money, to boot.

Where you usually have to do nothing to collect from the FDIC on direct CDs, the brokered CD payoff process is cumbersome and time-consuming because there’s a middleman involved.

There’s paperwork to submit, and time wasted processing it.

The standard brokered CD disclosure warns about “the possibility of an indeterminate delay in receiving insurance payments.”

That means, for me, extra sensitivity to the financial soundness of the bank (shown, for example, in Bankrate’s Safe & Sound ratings).

I’m not looking for firsthand experiences here.

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