Published in the ECHO Journal, September 2008
Most of us have heard that the government agency, the Federal Deposit Insurance Corporation (FDIC), insures deposits up to $100,000. What some people don’t realize is that the insurance limit is per depositor, not per account. For example, banks will suggest that you can increase your insurance limit by setting up individual accounts, joint accounts, accounts with your children, etc. to obtain more than $100,000 of deposit insurance with their bank.
In a homeowner association, there is only one depositor. The association is a corporation (most of the time) or an unincorporated association (occasionally). Whether the funds are operating or reserves, checking, money market funds or CDs, there is only one insurance limit for an association at any one bank—$100,000. Therefore if an association maintains a $10,000 operating account, a $50,000 money market account and a $95,000 CD with the same bank (a total of $155,000), only $100,000 of these funds are insured, leaving $55,000 uninsured. Incidentally this $100,000 limit has not been raised since 1980.
When a CPA reviews the financial statements of an association, one of the issues that they consider is whether the association has uninsured funds. This disclosure, if significant, is made in the Notes to the Financial Statements and can also be included in any separate correspondence between the CPA and the association. For many years, the risk of loss from uninsured funds has been considered to be minimal. There have been few bank failures in the past 15 years. Even when there were numerous bank failures in late 1980s, many times an acquiring bank would assume all the deposits of the failed bank, even those deposits greater than $100,000.
Then, on July 11, 2008, along comes the news that, IndyMac Bank, headquartered in Pasadena with 33 branches in Southern California was taken over by Federal regulators. According to some early news reports, a Congressman noted his concern about the bank in late June, which led to substantial withdrawals of funds by depositors. Bank regulators maintain a secret list of about 90 banks that they believe are in trouble to which they pay extra attention, but IndyMac Bank was not even on that list.
According to the initial press release, the FDIC will cover all insured deposits in this bank (up to $100,000) plus 50 percent of the uninsured deposits. So, in the example of the association in the first paragraph, there would be insurance on the first $100,000, plus half of the $55,000 ($27,500), leaving $27,500 as a potential loss for the association. “If it is determined that you have uninsured funds, the FDIC will generate and mail to you a Receiver Certificate. The Certificate entitles you to share proportionately in any funds recovered through the disposal of the assets of IndyMac Bank, FSB. This means that you will eventually recover some of your uninsured funds.”
If your association has uninsured funds, you should consider redistributing some of them so that all your accounts are insured. Checking and money market accounts are the easiest accounts to move because they have no early withdrawal penalties. Certificates of Deposit, if closed prior to maturity, have penalties for early withdrawal based upon the term of the investment, with higher penalties for longer-term investments.
Many banks have been negatively impacted by the home mortgage crisis and other loan losses. Some of our area’s banks are privately or closely held which makes it more difficult to determine how sound the bank is. One local bank has seen its stock price drop by 2/3rds in the past two years. So it would be prudent for any association with deposits greater than $100,000 in any one bank to consider reducing its exposure to uninsured funds as soon as practical.
What about Money Market accounts that are not in banks? Some associations have cash in money markets at stock brokerages such as Fidelity Investments, Merrill Lynch, Charles Schwab, etc. Accounts at these kinds of companies are insured by the Security Investors Protection Corporation (SIPC). According to www.sipc.org, SIPC insurance does not work the same way as the FDIC in terms of blanket protection of losses. The SIPC gets involved when the brokerage that you have cash, stocks and other securities gets into financial trouble and these assets go missing. The SIPC does not insure brokerage money market accounts.
For example, here is the disclaimer on the Schwab Money Market Fund: An investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation (FDIC). Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
And here is what is said about the Fidelity Cash Reserves Fund: An investment in the fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. The rate of income will vary from day to day, generally reflecting changes in short-term interest rates. Entities located in foreign countries can be affected by adverse political, regulatory, market, or economic developments in those countries. Changes in government regulation and interest rates and economic downturns can have a significant negative effect on issuers in the financial services sector. A decline in the credit quality of an issuer or the provider of credit support or a maturity-shortening structure for a security can cause the price of a money market security to decrease.
At the end of the day, nearly all bank accounts and money market funds carry some element of risk. It is important for you to understand what the risk is and take any steps to help minimize your risk and your association’s exposure to loss.
Michael Gartzke, an ECHO member, is a Certified Public Accountant with a large homeowner association practice in the Santa Barbara area. He is also the coordinator of the South Bay Homeowners Group with a membership of about 120 associations. He is a frequent contributor to the ECHO Journal.