U.S. raises deposit insurance limit; change will boost already rising CD wrappers, industry insiders say

By Kenneth Lim

Boston, Oct. 3 - Certificates of deposit could become a bigger part of the structured product scene after new legislation was passed to raise the amount that can be insured, industry insiders said.

"This is definitely a positive piece of news for the industry," a structured product distributor said.

The U.S. government approved and signed a $700 billion financial bailout plan on Friday. Part of the new legislation includes a provision that will increase the amount of savings insured by the federal government to $250,000 per account from $100,000 per account until the end of 2009.

Sheila Bair, chairperson of the Federal Deposit Insurance Corp., told news media on Friday that she expects the limit increase to eventually be made permanent.

Boost for structured CDs

The change comes as CDs are already experiencing an increase in investor interest amid a flight to safety.

"There couldn't be a better time to be offering CDs," the distributor said.

Because CDs are insured by the FDIC, holders of structured CDs are not exposed to a default risk if the issuer goes bankrupt, a scenario that struck when Lehman Brothers Holdings Inc. filed for bankruptcy in September.

"That kind of protection goes a long way especially today," the distributor said. "There's a lot of fear about the true credit worthiness of some of the banks, and making things worse is the fact that there's still a lot of confusion about what happens to a structured note if the issuer defaults."

The limit increase will allow an investor to buy more structured CDs with each bank in order to enjoy the insurance, the distributor said.

"Each account holder used to be insured for up to $100,000 at each bank," the distributor said. "That means if I buy $100,000 of CD A and $150,000 of CD B from JPMorgan, for example, I'm still only insured for up to $100,000 at JPMorgan, so I may not want to buy any of CD B. Obviously that limits how much investors can buy in CDs and how much we will eventually sell. If the limit goes up to $250,000, that more than doubles the potential for this particular wrapper."

CDs still cost more

But CDs will continue to cost more than structured notes, the distributor said.

"Banks have to pay for the insurance," the distributor said. "They may have to pay more to insure $250,000 than $100,000. There's a chance that it could eat into margins at the issuers. It might affect the issuers, but that's not really going to affect us."

Suzi Hampson, a structured products analyst with Future Value Consultants, explained that CDs in general are more expensive than notes if only because the banks have to pay for the insurance.

"The terms and the products are a little bit less attractive than you would see in a normal note," Hampson said. "Up until recently investors were more happy to take the risk of not having insurance in exchange for more attractive products, but I guess in light of recent events the prospect of having insurance and principal guarantee is more attractive to investors, and I guess issuers have caught on."

The higher $250,000 limit would make CDs more attractive to issuers, Hampson said.

CDs in the United Kingdom, where Future Value is based, have also been gaining in popularity, where they are often offered alongside note structures, Hampson said.

"We do see that," she said. "We have big banks issuing them, small banks and building societies do a lot of them, and they'll also have a normal note, so investors can choose how they want to do it. I think they are becoming more popular."

Getting information about CDs could also be more troublesome because the prospectuses do not have to be publicly registered, Hampson said. Future Value, for example, has been able to publish research notes on almost all the structured notes issued in the United States because the prospectuses are easily available, but its coverage of structured CDs has lagged because the information is harder to come by.

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