As financial institutions continue to see deposits run off their balance sheets due to higher interest rates and inflationary pressures, many have begun to lean on a variety of wholesale funding options. With the cost of funds increasing across the board, it is imperative to think outside of traditional avenues like certificate specials and expand secondary sources. Keeping marginal funding costs at a minimum while supporting loan demand and maintaining deposit franchise values can be a difficult dilemma. One option that accomplishes these goals is brokered deposits, which, given the current environment, have come back into the spotlight.

The Resurgence of Brokered CDs

Brokered deposits are not new; however, thanks to a combination of need from depositories and hunger from the potential investor base, they’ve had a year worth remembering. Outstanding brokered deposit balances, as shown in Exhibit 1, reached their highest levels on record at $450bn in 2022, according to Depository Trust and Clearing Corporation (DTCC). This expanding market opens the door for banks and credit unions to fill in the gaps of a potentially shrinking core deposit base.

For banks, the utilization of brokered deposits is a simple task: so long as the bank is well-capitalized, it can pursue the issuance of brokered deposits as a liquidity source. For credit unions, the use of brokered deposits is a bit more complex, with the most important qualification being a low-income designation. Under the current NCUA regulations, only low-income designated credit unions (LICUs) are granted the

authority to secure non-member funding up to the greater of 50% of paid-in and unimpaired capital or $3mm. While Non-LICU’s can issue brokered deposits, their permitted distribution channels are limited to other credit unions and government entities. This limitation generally raises all-in funding costs by 30-50 basis points (bps) which may make issuing brokered deposits less economical than other comparable sources.

02 Feb Ask Alm First Exhibit 1

Benefits to Your Funding Strategy

The ability to retain low-cost, sticky deposits is especially valuable to deposit franchises in market environments where interest rates are on the rise. However, the challenge facing institutions today is finding a way to raise deposit rates without cannibalizing their current deposit base. When liquidity is tight and funds are at risk of walking out the door, one of the natural first steps is to increase deposit rates or run CD specials. Often, this simply reprices existing deposits. Brokered deposits offer a nice alternative without running this risk.

Another benefit of issuing brokered deposits is the diversification it adds to your liquidity management strategy. Brokered deposits aren’t technically borrowings and will serve to reduce loan-to-deposit ratios while increasing leverage. Additionally, because brokered deposits aren’t collateralized, institutions can keep the collateral in their portfolios “free” for FHLB borrowings or reverse repo, while raising much-needed cash to maintain loan demand or invest in other parts of the balance sheet. For institutions that may be running near their FHLB borrowing capacity, utilizing brokered deposits could provide the ability to pay some of these existing lines down and strengthen contingency funding capacity.

Diversifying your depository’s sources of funding also creates agility in your funding strategy. Take for instance an institution which rolls short term brokered deposits, such as a 3-month term, and synthetically extends the duration using a pay-fixed swap in a cashflow hedge. If the brokered deposit market were to become more expensive than alternatives, the institution would be able to replace the funding with a 3-month FHLB advance or other “SOFR-like” sources, and the cashflow hedge relationship would stay intact. As shown in Exhibit 2, short-term brokered deposit rates are heavily correlated with Fed Funds and SOFR rates. This relationship paves the way for hedging strategies like the one described above, allowing the institution to swap in the most cost-effective funding source while maintaining an optimal liability duration throughout the process.

02 Feb Ask Alm First Exhibit 2

Adding Flexibility to Your Toolbox

While the brokered deposit market is not new, its resurgence has opened another gateway for depositories to explore in their search for liquidity. It’s important to your institution’s performance to explore all funding options to control costs and manage risk. Consideration should be given to ease of raising funds, stability of the source and the cost incurred. Brokered deposits offer a relatively quick and competitively priced method of raising funds without cannibalizing your core deposit base. Familiarizing yourself with the product and process of issuing will add to your toolbox and provide flexibility in funding asset growth and managing liquidity events.

Contact ALM First’s team of experienced professionals to learn more about liquidity management and discuss how to expand your funding options today. Find out why over 300 clients have chosen ALM First as their trusted partner for unbiased advice.

To download the full PDF article, click here.

ALM First” is a brand name for a financial services business conducted by ALM First Group, LLC (“ALM First”) through its wholly owned subsidiaries: ALM First Financial Advisors, LLC (“ALM First Financial Advisors”); ALM First Advisors, LLC (“ALM First Advisors”); and ALM First Analytics, LLC (“ALM First Analytics”). Investment advisory services are offered through ALM First Financial Advisors, an SEC registered investment adviser. Access to ALM First Financial Advisors is only available to clients pursuant to an Investment Advisory Agreement and acceptance of ALM First Financial Advisors’ Brochure. The content in this message is provided for informational purposes and should not be relied upon as recommendations or financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues.

The content in this article is provided for informational purposes and should not be relied upon as recommendations or financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. While such information is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. Statements herein that reflect projections or expectations of future financial or economic performance are forward-looking statements. Such “forward-looking” statements are based on various assumptions, which assumptions may not prove to be correct. Accordingly, there can be no assurance that such assumptions and statements will accurately predict future events or actual performance. No representation or warranty can be given that the estimates, opinions or assumptions made herein will prove to be accurate. Actual results for any period may or may not approximate such forward-looking statements. No representations or warranties whatsoever are made by ALM First Financial Advisors as to the future profitability of investments recommended by ALM First Financial Advisors.

© 2023 ALM First Group, LLC. All rights reserved.