Brokered CDs are Certificates of Deposits (CDs) usually issued in large denominations by banks via a "master CD" to deposit brokers (a broker/dealer that sells brokered CDs), which in turn sell interests in the master certificate to individual investors. The characteristics of Brokered CDs may have a longer holding period until maturity date, be more complex, and carry more risk than "traditional" CDs. To compensate for these additional features, brokered CDs frequently pay a higher interest rate than traditional CDs.
The master CD is a negotiable instrument that represents a certain number of individual CDs, each with the same denomination. FDIC insurance may attach to the individual CDs represented in the master CD. The master CDs are held by a deposit broker as a custodian or by a sub-custodian appointed by the deposit broker. Either the deposit broker or the sub-custodian keeps the records of its customers' ownership interests in the CDs. In general, brokered CDs have longer maturity dates (in some cases, 20 years from the date of issuance), than traditional CDs. The interest rate terms of brokered CDs can also differ significantly from the simple interest rate terms generally used by traditional CDs. Brokered CDs also may have special call features that allow the issuing bank to terminate the CD after a specified period of time if interest rates drop. In this respect, the CD is similar to a callable, fixed-rate bond.
Issuing banks may impose penalties on investors for withdrawing their funds before the maturity date of the CD or may not allow withdrawal prior to the maturity date. As a consequence, the market conditions for the sale of Brokered CDs prior to maturity do not always favor the customer. For instance, if interest rates are high and a customer wants to trade in a low interest brokered CD for another CD with a higher interest rate, the customer might have to realize a loss on the principal in order to sell the CD.
RISKS ASSOCIATED WITH BROKERED CD's.
1. Loss of Principal
If a brokered CD is sold prior to the CD's maturity, the pre-maturity sales price of the brokered CD may be less than its original purchase price and a significant loss of principal could result. This will be particularly true if interest rates have risen since the time of the original sale. Buyers, including members, will not generally be interested in buying a lower interest rate CD in the secondary market if a higher rate CD can be purchased in the primary market.
2. Secondary Market
The secondary market for brokered CDs may be limited. The firm, though not obligated to do so, may maintain a secondary market in this CD upon completion of the distribution.
3. Call Features
Brokered CDs may include a provision that allows the issuing bank, or other depository institution, to "call" or redeem the CD prior to maturity at a given price. Call