As lawmakers in Washington grapple with reforming the nation's banking system, MNC Financial Inc. has aggressively used one of the most controversial banking strategies to replace millions of dollars in local deposits with out-of-state funds.
Whether financially troubled MNC was scrambling to offset a painful loss of local customer confidence -- as some analysts believe -- or whether the company's banks were simply using a cheaper and safer way to pull in stable deposits -- as the banks contend -- remains arguable.
Quite evident, however, was that MNC stepped into a heated national debate that has some lawmakers blaming these potentially volatile deposits for subverting the intent of the nation's deposit insurance.
According to recent regulatory filings, MNC's two banks -- American Security Bank in Washington and Baltimore-based Maryland National Bank -- more than quadrupled their dependence on so-called brokered deposits. Typically, those are certificates of deposit that are sold through the nation's brokerage houses.
Indeed, by the end of 1990, roughly 40 cents of every dollar deposited at American Security came from these out-of-state deposits.
This level represents a ninefold increase in American Security's brokered deposits since the start of the year, according to regulatory filings. Maryland National Bank's proportion more than tripled during the same period.
"It was to be expected," said Elisabeth Albert Hayes, a banking analyst at Chapin, Davis & Co. "What the brokered deposits were doing was replacing the large balances. Anyone who had (( over $100,000 at the bank had to seriously be thinking 'What are we doing?' "
Whether brokered deposits are a friend or foe, savior or demon to the banking industry simply depends on who is asked.
A recent Treasury Department plan aimed at reshaping the American banking system has called for virtually stripping these accounts of their federal insurance protection within two years.
Extending banking insurance to these deposits and "expanding
the ability of firms to use the government's credit, rather than their own financial condition" to attract depositors "is an invitation for increased risk and an increased misallocation of resources," the Treasury Department contended.
The report quoted a former chairman of the Federal Deposit Insurance Corp., William M. Isaac, as saying in 1985: "It is a simple fact that troubled banks and thrifts use brokered funds more frequently and more extensively than well-rated institutions."
Defenders of the current system, however, claim that using brokers to find willing depositors merely taps a much-needed source of liquidity for banks that, for one reason or another, are unable to attract enough financing near home.
The method for brokering deposits is relatively simple. A bank decides that it needs a certain level of funding for a specific duration and contacts a brokerage house that trades through a national network. The brokers, who earn a commission on the sales, can place CDs -- which currently average about $20,000 -- issued by the bank with their retail customers. Those customers are then covered up to $100,000 in federal deposit insurance, as if the CD were purchased directly from the issuing bank.
These deposits have become particularly attractive to banks in areas such as Washington, where local competition has raised the interest rate that banks must pay on CDs above the national average.
According to the weekly newsletter, Bank Rate Monitor, this region's banks continue to offer the highest average rates on certificates of deposit of any metropolitan area in the nation. Banks pay an average annual yield of 7.14 percent, nearly half a percentage point above the second-ranking New York area.
"When you get into a rate-war situation in a city, you get a very volatile situation," said Al Disposti, managing director of Merrill Lynch & Co. Inc., which handles roughly 30 percent of the brokered deposit market. "Brokered deposits give you a more stable deposit base."
But regulators still worry, citing the checkered 10-year history of brokered deposits. The use of brokered deposits has been linked to the downfall of many large banking companies.
People who buy brokered deposits have little allegiance to anything but interest rates. So, they are quick to yank their money out of the bank in times of trouble or when higher rates are offered elsewhere.
This so-called "hot money" has been behind many of the nation's fastest-growing -- and hardest-falling -- banks and thrifts, which used funds bought at high rates to back risky and expensive loans. When these institutions failed, brokered deposits were viewed as a culprit. Critics charged that the "hot money" either fueled the rapid growth, or ran at the first sign of trouble and caused a bank's liquidity to dry up.
There is little doubt among analysts -- and some MNC executives, when pressed -- that MNC turned to the national markets to replace millions of dollars of uninsured money pulled from the banks last year.
Swamped by failing real estate loans, the banking company suffered a loss of $440 million during the year. Meanwhile, its credit rating for certain debt fell well into the speculative grade.
At the beginning of last year, MNC's two banks had a combined $825 million in total brokered deposits, representing about 8 percent of the combined $9.9 billion in domestic deposits at the two banks.
Within 12 months, the combined total of brokered deposits hadclimbed to nearly $4.8 billion, or about 30 percent of the $15.8 billion in total domestic deposits at two banks. Equitable Bank, which merged into Maryland National last summer, had no brokered deposits prior to the merger.
"Yeah, it's a large increase," said John A. Heffern, a banking analyst with Alex. Brown Inc. "But it's not surprising given the pressure the company has been under and the regularity with which their problems were discussed in the media."
MNC executives defend their reliance on brokered deposits, claiming that the bulk of those purchased were retail deposits sold to small customers who were willing to lock in for a few years. Indeed, MNC said, they were cheaper and more stable than many similar deposits they could have obtained locally.
Peter L. Gartman, MNC's chief financial officer, said the average length of the brokered deposits was about two years and they thus were "very, very stable."
In addition, by tapping the national market, the cost of the funds was between one-quarter to one-half of a percentage point cheaper than the bank would have paid in the local market. "In essence, all you have is one person and a telephone" selling the CDs, he said.
By using other financing methods, the bank also offset any squeeze on profitability that occurred in the past year as interest rates were falling, the banking company said.
John B. Works, a vice president at Keefe, Bruyette & Woods in New York, supported the bank's view that the source of funds was stable.
Using a "hot funds" ratio that the banking research firm has devised, MNC ranked in the middle of the firm's universe of 140 banking companies, based on a ratio of "hot" or volatile funds carried on the bank's balance sheet.
Regardless of the controversy, MNC said the argument is moot. Mr. Gartman said the banks stopped shopping for brokered deposits in early November and probably would not return to the market for many months.