NEW YORK – Investors seeking the safety of government-insured certificates of deposit and a chance to profit from market rallies may end up earning nothing and owing taxes for their efforts.
Wells Fargo & Co. and Sovereign Bank are among those providing certificates of deposit tied to equity indexes, commodities or currencies. Wells Fargo sold about $5 billion of these market-linked CDs last year, up from $90 million in 2002, while Sovereign’s CD, which links to the performance of the Standard & Poor’s 500 Index, has attracted $1 billion since October.
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“Market-linked CDs are a great selling tool for nervous nellies, but they don’t realize what’s involved,” said Tom Balcom, founder of Ibis Wealth Management in Boca Raton, Fla. The products blend safety with the potential for higher returns than current time-deposit interest rates, because the principal is insured by the Federal Deposit Insurance Corp. If the index doesn’t gain, the investor may not earn anything.
Structured CDs tend to sell better in times of high volatility, said Tom Orecchio, principal at Modera Wealth Management, based in Westwood, N.J. Investors fled U.S. equities for the sixth straight week in the period ended June 9, pulling $3.7 billion from domestic stock funds, according to data compiled by the Investment Company Institute, a trade group in Washington.
“There are other ways to get similar returns without all the complications,” Orecchio said.
Sovereign, a subsidiary of Spain’s largest bank Banco Santander SA, offers customers a package: a six-month, traditional CD with 2 percent interest and a three-year CD that pays 2.9 percent annually if the value of the S&P 500 Index is higher than the purchase date at the end of every 12 months, said Nuno Matos, head of retail business for the company. If the index doesn’t rise, the investor doesn’t earn any interest, he said.
Market- or index-linked CDs are an estimated 15 percent to 20 percent of total volume in structured investments, about triple the percentage before the financial crisis of 2008, according to Richard Couzens, New York-based head of product origination for investor solutions at Barclays Capital, a unit of Barclays Plc.
Many firms that offer these products also sell structured notes, which are bank bonds with yields linked to stocks that don’t carry insurance. After Lehman Brothers Holdings Inc. went bankrupt in September 2008, leaving its structured notes worth pennies on the dollar, banks began offering more of the CDs, said Matt Ginsburg, San Francisco-based head of the customized investment solutions group at Wells Fargo.
“Because investors wanted FDIC insurance, you saw market participants step up their issuance of CDs,” Ginsburg said.
The limit on deposit insurance was raised in 2008 to $250,000 per account from $100,000, which also helped CD sales, Ginsburg said. The limit is scheduled to return to $100,000 after 2013, leaving larger CDs uninsured, unless Congress acts.
“Investors are desperate for yield, the Fed has created a zero interest-rate environment and it’s leading people to stretch,” said Frank Partnoy, professor at the University of San Diego School of Law and a former derivatives trader. “The banks are responding to that demand.”
The products are attractive to sell because they generate higher fees, Partnoy said. Commissions generally range from 1 percent to 3 percent, said Ginsburg.
