The following is a guest post contributed by Charles Rechlin, a long-time reader and friend of the site. His last guest post covered Relationship Rate CDs. I would like to thank Charles for sharing more of his valuable experience on personal CD investing.
Notes on Personal CD Investing: Revisiting Brokered CDs
by Charles Rechlin
Ever since US Treasury yields began improving in November, I’ve been accumulating a modest portfolio of 3-, 4-, and 5-year Wells Fargo Bank CDs.
Because Wells Fargo’s highest posted rate for direct CDs in California is a whopping 55 basis points (its 58-month special, with relationship bonus), I’ve been building this portfolio by purchasing the bank’s highly-competitive, non-callable brokered CDs. Late last month, for example, I bought, through Scottrade, a 3-year new issue CD yielding 1.80% and a 5-year new issue CD yielding 2.30%, using funds from a maturing 2.00% APY San Diego County Credit Union CD.
The purchase of even a small position in brokered CDs outside of my IRA accounts represents a significant departure for me from past investing practices.
Taking Advantage of Recent Higher Rates for Brokered CDs
In a two-part Blog post last summer, I compared my experience investing IRA assets in both direct CDs and brokered CDs. That piece covered the key features of, and some pros and cons of investing my IRA portfolio in, brokered CDs. I indicated that, based principally on the administrative convenience afforded by brokered CDs, I’d moved a large portion of my IRA portfolio from direct IRA CDs into brokered CDs over the last few years.
For my larger non-IRA portfolio, I’ve always gone the other way—establishing CDs directly with banks and credit unions, and eschewing brokered CDs. The principal drawback of brokered CDs, from my perspective, is their limited liquidity—they don’t provide for early withdrawals at the option of the owner, and have a relatively thin market. Also, brokered CD yields are usually lower than the APYs on direct CDs of the same bank with identical maturities.
This disparity in yields, however, sometimes flips. Because there’s a market for brokered CDs, their rates are often more sensitive to moves in Treasury yields than are those of direct CDs. Occasionally, when Treasury yields are rising, the rates offered on brokered CDs of a bank exceed those posted for the bank’s direct CDs of like maturity.
This has frequently been the case since Treasury rates first began moving up after the November election.
Consider the yields for prominent bank new issue brokered CDs offered through Fidelity, Vanguard and Scottrade during the last week of February, compared with posted rates for direct CDs of those banks:
Capital One—the yields for 3-, 4- and 5-year brokered CDs of Capital One Bank (USA), N.A. were 1.80%, 2.10% and 2.30%, respectively, compared with APYs of 1.60%, 1.80% and 2.00%, respectively, for direct CDs of the same maturities posted online by its affiliated bank, Capital One, N.A.
Discover—the yields for 2-, 5-, 7- and 10-year brokered CDs were 1.55%, 2.30%, 2.45% and 2.70%, respectively, in contrast to 1.30%, 1.76%, 1.95% and 2.20% APYs posted for the respective maturities offered on Discover’s website.
Ally—the yield for Ally’s 3-year brokered CD was 1.80%, while the posted rate for Ally’s online “high yield” 3-year CD was 1.60% APY (for the $25,000+ balance tier).
GS Bank—the bank was offering a highly-competitive 2.30% 5-year brokered CD, while posting a less competitive 1.85% APY for its online 5-year CD.
Sallie Mae—the yield for the bank’s 3-year brokered CD was 1.75%, compared with a posted APY for its 3-year direct CD of 1.60%.
(You can find brokered CD rates by visiting the websites of these broker-dealers and other broker-dealers having online trading platforms, although sometimes you must have an account to access rates. Also, the regular “CD Rates Summary” on DepositAccounts.com provides current top brokered CD rates by maturity, broker and bank.)
Although the recent disparity between brokered and direct CD rates illustrated by these offerings can be explained by the greater market sensitivity of the former, it’s not easy to explain the emergence of Wells Fargo as a leading player in the new issue brokered CD market.
Wells Fargo, which has not posted competitive direct CD rates for several years, seems to have begun offering competitive, standard maturity, non-callable CDs immediately following the Federal Reserve’s initial target Fed Funds rate hike in December 2015. Prior to that time, the bank’s brokered CDs were limited to longer-term instruments subject to early calls and often with step rates.
Today, Wells Fargo regularly offers through online brokers 13-month, 2-year, 3-year, 4-year and 5-year non-callable brokered CDs at yields that beat those of the most competitive Internet bank direct CDs.
It’s not clear to me why Wells Fargo, with its vast nationwide branch network, has chosen to offer these CD yields in the brokered CD marketplace, while denying them to its brick-and-mortar customers. Perhaps it believes that the new issue brokered CD market allows it greater control over funding its requirements for term deposits.
Whatever the reasoning, I’ve been taking advantage of what Wells Fargo has been doing to obtain what I consider favorable yields.
Limiting My Exposure to Brokered CDs
On the other hand, I’m not exactly plunging head-long into brokered CDs for my non-IRA portfolio. Right now, my Wells Fargo CDs (the only brokered CDs I own outside of my IRA) account for less than 2% of my taxable investment assets.
Despite their poor liquidity, brokered CDs actually have a “market value” (displayed on your online account pages) that fluctuates from time to time depending in large part on prevailing interest rates. As a result, you really must be prepared to hold these investments to maturity. There’s no early withdrawal value you can fall back on if you have to exit before maturity.
From a valuation standpoint, I do take some comfort, however, in what is variously called the “conditional put,” the “death put” or the “survivor option,” a feature normally found in direct CDs as well. The “Certificate of Deposit Disclosure Statement” Scottrade provides to investors describes this as follows:
“In the event of death or the adjudication of incompetence of the owner of a CD, early withdrawal of the entire CD will generally be permitted without penalty.”
The use of the loaded word “generally” makes the comfort I get from this language somewhat colder than it otherwise might be. I suppose to fully understand this weasel wording would require drilling down on paperwork and market practices, broker-by-broker, bank-by-bank, to an extent I haven’t the energy to do.
(Then again, many early withdrawal disclosures for direct bank CDs, requiring prior bank consent and/or allowing the bank to amend terms of CDs, including EWPs, also leave me feeling a bit chilly.)
Anyway, because I believe interest rates will continue to rise (which will inevitably lower the “market value” of—but not the balance due on—my brokered CDs), and because I’m relatively certain that the current disparity between brokered and direct CD yields will flip again, I’m taking it slow and easy. With this cautious approach, I expect that brokered CDs, while a viable investment option for me from time to time, will never constitute a large part of my non-IRA CD portfolio.