Centralized

The collateralized CD market has been a black box for public agencies, where useful information on rates has been hard to come by and public agencies are hampered in assessing relative value. We’ve created a series of new investment benchmarks to address this by tracking rates that banks pay for collateralized public funds deposits. It will give public agencies a valuable tool for managing their investments and tracking results. These benchmark indices of three-, six- and 12-month collateralized CD rates are now posted on our Investment Dashboard and will be updated weekly. And a new dashboard function will allow comparisons with other money market yields.

  • Benchmarks exist for other widely used securities, such as Treasuries, Federal agency securities, corporate obligations, local government investment pools and money market funds. These securities trade in national over the counter markets where transactions are recorded centrally (for Treasury Federal agency, and corporate securities) or postings are broadly advertised and the Federal Reserve, among others, produces regular benchmark indices (for commercial paper). Money fund yields are tracked by Cranedata and by us.  We also maintain benchmarks of LGIP yields.
  • The new PFII CD benchmarks are built to fill the void. They are based on transactions executed by seven state treasurers who manage collateralized time deposit investment programs for their states. These states run regular bidding programs for time deposits and make available the market-clearing rates at which they invest. To create the benchmarks these transactions are normalized using rates on comparable-maturity Treasury bills and combined into the PFII indices. Normalization is accomplished by relating the bid rates to a margin or spread compared to a related on-the-run Treasury bill. This “Bill basis” is the method some of the states use directly in setting rates they will pay; in other cases it is calculated by PFII as part of the benchmark construction process.
  • We will update the benchmark rates weekly as of the last business day of the week, thus corresponding with the dates of the PFII LGIP and money fund indices and the reference rates for other short term securities that are published on the Investment Dashboard page of our website
  • Collateral requirements for CDs are specific to each state—there is no single national standard—and the terms, particularly the types of collateral and collateral margin requirements, even may differ from municipality to municipality within a state. Since posting collateral is a “cost” of any collateralized investment transaction, identifying fair value for a particular public agency should take this into account. The best practice method for doing this when using a diverse benchmark such as the CD rate indices is to determine the margin or spread of rates your banks propose compared to the PFII benchmark. As is the case with other fixed income benchmarks (for corporate bonds or commercial paper for example) a public agency should be able to build and track  its CD trade history compared to the benchmark, adjust the benchmark by this margin for analytic purposes and observe (and seek explanations for) any changes in the margin over time.

 

Deep dive

Rates and terms for collateralized bank certificates of deposit are not a transparent area of the public funds investment market. Although CDs are a core investment holding for many municipalities their rates and terms are uniquely opaque. Bank deposits account for about $800 billion, or 20% of total public unit investment assets, second only behind Treasuries, with about half of this in investment-type bank accounts and the rest in transaction accounts according to Federal Reserve data. For many smaller and mid-sized public units bank deposit instruments and LGIPs are the only investments they utilize.

Public agencies have little information on market level rates when they negotiate and place deposits. Banks quote rates for collateralized public funds deposits only by request—they do not post or advertise them widely. So a public agency is likely to get a picture of offered rates only when actively shopping to place investments. More important, offered rates are not necessarily the levels where transactions are completed. (Obviously (?) if I advertise the sale of my car for $10,000 then sell it to someone for $8,000 the market value is the consideration I received. The asking price is not fair value )

Assessing market levels is further complicated by the lack of uniform collateralization for public units. Some states have a statewide program, while in other states the specifics of collateralization—which securities are eligible, the specific margin requirements, etc.—are open to negotiation between the bank and the public unit (sometimes with state-specific limits). Collateralizing deposits has a cost which should be reflected in the deposit rate but without uniform collateral requirements it can be challenging to compare collateralized CD rates across municipalities.

We believe the benchmarks will be very helpful to public funds investors, but they have some limitations. A high-quality benchmark should measure frequent mid-market values for actual transactions involving common securities. For example, Treasury benchmarks are based on daily trading volume of more than $1 trillion(!). The bespoke nature of collateralized CDs does not allow for this, but by collecting and normalizing the results of bids that are acted on by seven state treasurers we are able to provide benchmarks that are national in scope and current. (We plan to expand the survey data over time to include additional public units that collect CD bids on a regular basis.) CDs underlying the indices total more than $2 billion across dozens of banks.

The relative value of collateralized CDs

We’ve been collecting and compiling data for the benchmarks since July,2024. That’s not a long history. But our analysis documents the relative value of collateralized CDs in the marketplace. Based on this we’ve observed the following:

  • CD rates “anticipate” general interest rate moves. Banks set rates to fund their deposit requirements over a time horizon. When they foresee rates moving up or down they are likely to adjust their offering levels before there are general moves. To illustrate, here is a chart of three- and 12-month CD rates compared with federal funds. Note the sharp decline in CD rates last summer in advance of the Fed’s move in September to cut rates.

Bank Rates

 

  • Rates on collateralized CDs are lower than rates on unsecured short-term bank instruments like commercial paper. As we observed, collateral has a cost that banks rightly factor into the rates that they offer for public unit CDs. In the period since July, 2024 our 3-month CD rate index averaged 18 basis points less than the rate on 90-day commercial paper compiled by Bloomberg. This represents the credit and cost differentials. Comparing the two indices also can highlight when one is rich or cheap vs. the other. (The spreads ranged from ten to 26 basis points over this period.)
  • CDs may provide an attractive fixed rate alternative to rates on LGIPs, particularly in a declining rate environment, but a great deal depends on the tenor of the CD and the speed at which rates decline. The chart at the top of this post compares rates on three- and 12-month CDs with yields on prime LGIPs as measured by the PFII Prime LGIP Index. Locking in fixed rates, either in a CD a Treasury or other fixed rate instrument, at the start of the Fed’s easing program would have added value to a portfolio although it would have entailed giving up some initial yield to do so. Once easing got underway the opportunity quickly vanished as other market forces came to the fore. 

Collaterized

 

Bottom line

Collateralized CDs are a means to lock in fixed rates and target maturity requirements in managing cash flow. The CDs are normally not liquid, but they offer a way to fix earnings and can be secured by collateral. Transparency around rates should help public unit investment managers identify opportunities to lock in rates and to negotiate fair market terms with banks.