CDARS are explicitly authorized by in Section 53601
Defintion of CDARS (taken from Wikipedia)
The Certificate of Deposit Account Registry Service (CDARS), is a private, patented, for-profit service that breaks up large deposits (from individuals, companies, nonprofits, public funds, etc.) and places them across a network of more than 3000 banks and savings associations around the United States. This allows depositors to deal with a single bank that participates in CDARS but avoid having funds above the FDIC deposit insurance limits in any one bank.
The service can place multiple millions in deposits per customer and make all of it qualify for FDIC insurance coverage. With the CDARS service, the customer’s local bank sets the interest rate that will be paid on the entire deposit amount, and the customer gets one consolidated statement from that bank.The service is used by community and regional banks to obtain deposits they would otherwise be unable to get. The company that provides CDARS, is Promontory Interfinancial Network.
Legal Authorization
Depending upon how your investment policy is written the policy may have to be updated to invest in CDARS. CDARS are explicitly authorized by Section 53601.8 of the Government Code. Below is the text of the law:
Notwithstanding Section 53601 or any other provision of
this code, a local agency that has the authority under law to invest
funds, at its discretion, may invest a portion of its surplus funds
in certificates of deposit at a commercial bank, savings bank,
savings and loan association or credit union that uses a private
sector entity that assists in the placement of certificates of
deposit, provided that the purchases of certificates of deposit
pursuant to this section, Section 53635.8, and subdivision (i) of
Section 53601 do not, in total, exceed 30 percent of the agency's
funds that may be invested for this purpose. The following conditions
shall apply:
(a) The local agency shall choose a nationally or state chartered
commercial bank, savings bank, savings and loan association, or
credit union in this state to invest the funds, which shall be known
as the "selected" depository institution.
(b) The selected depository institution may submit the funds to a
private sector entity that assists in the placement of certificates
of deposit with one or more commercial banks, savings banks, savings
and loan associations, or credit unions that are located in the
United States, for the local agency's account.
(c) The full amount of the principal and the interest that may be
accrued during the maximum term of each certificate of deposit shall
at all times be insured by the Federal Deposit Insurance Corporation
or the National Credit Union Administration.
(d) The selected depository institution shall serve as a custodian
for each certificate of deposit that is issued with the placement
service for the local agency's account.
(e) At the same time the local agency's funds are deposited and
the certificates of deposit are issued, the selected depository
institution shall receive an amount of deposits from other commercial
banks, savings banks, savings and loan associations, or credit
unions that, in total, are equal to, or greater than, the full amount
of the principal that the local agency initially deposited through
the selected depository institution for investment.
(f) Notwithstanding subdivisions (a) to (e), inclusive, no credit
union may act as a selected depository institution under this
section or Section 53635.8 unless both of the following conditions
are satisfied:
(1) The credit union offers federal depository insurance through
the National Credit Union Administration.
(2) The credit union is in possession of written guidance or other
written communication from the National Credit Union Administration
authorizing participation of federally insured credit unions in one
or more certificate of deposit placement services and affirming that
the moneys held by those credit unions while participating in a
deposit placement service will at all times be insured by the federal
government.
(g) It is the intent of the Legislature that nothing in this
section shall restrict competition among private sector entities that
provide placement services pursuant to this section.
Advantages and Disadvantages of CDARS based on responses of CSMFO Members
Advantages
1. It is possible to invest $1 million in one CD rather than numerous CDs.
2. An investment in a CDAR with a community bank becomes a community investment opportunity if it structured as a “reciprocal transaction” rather than a “CDARS one-way” transaction.
3. Although rates may be lower than CDs they are generally higher than treasuries at the current rates.
4. CDARS are not callable unlike many Agency Bonds.
5. The City receives the FDIC insurance for up to $250,000 from each bank participating in the CDAR.
Disadvantages
1. In some cases you cannot specify the other banks. This means you will not be able to evaluate their credit worthiness and may end up in investing in a failed bank. This actually happened to one of the cities responding, although there was no problem getting 100% of the City’s money back. This may cause some headlines in the local newspaper if there is a problem with one of the banks participating in the CDAR.
2. CDARS are not liquid investments. There are no secondary markets and there is a penalty for early withdrawal so you can only invest what you will not need in the near term.
3. Once you make such an investment with a community bank it may be expected that you would keep renewing the CDAR, thus you would lose flexibility.
4. CDARS may not be suitable for the investment of bond proceeds.
5. You need to reconcile every month with your statement to make sure that you don’t invest in a bank that the City already has an account with in order to maintain the protection of the FDIC $250,000 guarantee.
Questions to ask (provided by respondents to CSMFO survey)
Who are the issuing banks?
Who qualified them?
Who does the credit review of the issuing institutions?
How often?
How are the review results communicated back to you?
Are the CDs collateralized and if not are you comfortable waiving collateralization for the FDIC insured deposits?
This information was compiled by CMSFO Member, Sandra Sato from various sources in response to a February 14, 2011 CSMFO survey. Information from a survey taken in 2009 by another member was also used in the compilation.
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