If the US Defaults in October, Is Cash the Only Safe Place to Hide?

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Cash is always the safest place to put your money in a crisis. Against the prospect of a dramatic slowdown in the economy stemming from a sovereign default, cash again seems like a safe haven. A US default will lead to real stock and bond market declines and almost certainly a drop of commodity and real estate values.

Even in periods of historically low rates on cash instruments, savings and money market accounts often outperform all other instruments, especially if all other instruments suffer a synchronized decline following major economic disruptions. 

With online instruments offering 0.85% to 0.90% these days, cash is not sexy.   In fact, those who stayed heavily in cash over the last four years have missed out on a historic move in the stock market.  They have also missed out on bond and asset price appreciation.  Perhaps most importantly, they have lost purchasing power as savings and money market accounts have not kept up with inflation (especially after accounting for tax consequences).

Today, real estate, bonds and the stock market have all seen dramatic and real runs, not all entirely consistent with economic realities.  Regardless, the impasse in Washington and the prospect of a sovereign default by the US if the debt ceiling is not raised, argues especially persuasively now in favor of stepping aside for a bit. 

Of course investors with a time horizon beyond a couple of weeks would be imprudent to dump all assets and move completely into cash. With the Fed having chosen not to taper and the dovish history of the likely incoming Chair, Janet Yellin, who is committed to keeping rates low until unemployment falls below 6.5%, cash may not be an ideal place even at this time to assign new money. 

Many private and institutional investors, rather, have been focusing on high quality corporate bonds ever since the Fed’s announcement in September that it would not begin tapering at this time.  As I survey the landscape, one bond-like instrument that seems particularly interesting at this point is Public Storage’s preferred stock. 

I first wrote about Public storage’s preferred stock on BestCashCow in 2012.   All of the classes of Public Storage preferred stock that were available then were called at par value ($25) late in 2012 and early in 2013; the company subsequently issued new shares in the form of Class V and Class W at lower yields - approximately 5.25 and 5.45%.   Each class pays dividends quarterly and both traded above par earlier this year, soon after they were issued.  As of the date of this publication, however, both shares are significantly discounted with the V shares trading around $21 a share and the W shares around $20 a share.  In other words, both shares are trading with effective yields, plus or minus, of 6.45%.

While these shares have fallen quite sharply over the summer as long term bond yields went up, Public Storage (PSA) appears a very safe company in the face of a potential new Congress-initiated recession.  The Company is efficient and effective and its business model is pretty much recession proof.  Its debt and preferred stock, as a percentage of gross assets, is at historically low levels (below 30%) and it faces virtually no debt refinancing obligations in 2014.

As I noted in my 2012 article, preferred stock is an animal in and of itself and is ordinarily not a good place for individuals to park cash (largely because they are instruments of indefinite duration and because individuals cannot take advantage of many US tax incentives on ownership of preferreds made available to corporate purchasers).

Public Storage’s preferred stock is currently rated Baa1 by Moody’s, having been upgraded in late 2012.  While there is real risk of a decline in principal (a continued decline in principal for holders of the initial issuance) if and when interest rates rise again, a 6.45% yield on a Baa1 instrument is not otherwise attainable at the moment. Therefore, Public Storage’s preferred stock just might be a place for those investors seeking protection and return to assign some of their cash while waiting for Washington to sort itself out.


Massachusetts' Depositors Insurance Fund (DIF) Is Important for High Net Worth Depositors to Consider

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Many Massachusetts-based banks now offer competitive online savings accounts. Can depositors rely on the Commonwealth's Depositors Insurance Fund and deposit amounts over FDIC limits in these banks?

The Depositors Insurance Fund (DIF) was created in 1934 and, while independently operated, includes all Massachusetts licensed banks as members.  According to DIF’s website, the Fund extends coverage above and beyond FDIC limits to depositors at member banks regardless of their states of residency.

DIF has over $350 million in assets. During the recession of the early 1990s, the worst financial period in the history of the Massachusetts savings bank industry, DIF paid out more than $50 million to protect over 6,500 depositors in 19 failed member banks.   During the 2008 to 2011 bank crises, the DIF was not affected by the spate of bank failures as none of its members were among those banks that either failed or were seized by the FDIC.  Funds in the Massachusetts DIF are highly regulated today by the Massachusetts Division of Banks, and the fund again has significant reserves on hand to cover failures of member banks.

There are now three highly competitive online banks in Massachusetts, all members of the DIF.  Assuming the DIF website is correct that all depositors are covered regardless of their state of residency, a depositor who might otherwise be inclined to keep online savings accounts below the FDIC’s individual $250,000 insurance limit could now be covered in depositing well over that amount in a DIF member bank.

EBSBDirect, a subsidiary of East Boston Savings Bank, currently offers online depositors 2.50% on deposits up to $1 million in an online savings account.  Bank 5 Connect and Salem Five Direct are also Massachusetts-based banks that are covered by DIF and that have been competitive in the online savings / money market and CD spaces in recent years.   

Some Massachusetts-based banks have had some customer service problems in the past, and they may not provide online banking interfaces or customer services comparable to Ally or Marcus.  Salem Five Direct has bank fees that are excessive for online savings accounts and make it a less than desirable place to put cash that may be needed quickly and/or often.  BankFive Connect has a website with nice pictures but relatively sophomoric customer service.

Depositors for whom FDIC limits are not an issue may find that it makes more sense to stick with well-recognized online banks and their superior customer services.   Even many depositors with $2 million or so to deposit in online savings accounts may find that they can achieve their goals and stay within FDIC limits by distributing their money among several banks with outstanding customer service.  However, depositors seeking to hold significantly larger amounts in online savings and money market accounts may find the protection they require from Massachusetts’ DIF insurance and deposit amounts above FDIC limits in one or more of these Massachusetts-based online savings and money market accounts.


Duke Energy's PremierNotes Are An Inappropriate Place to Stash Cash

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Duke Energy has begun to advertise an unsecured commercial paper program. While the company is offering yields that are as high as 1.51%, these notes are uninsured, and hence represent an inappropriate place to stash cash for most.

No matter what the environment, most people have some amount of money that they cannot afford to lose.   And, in order not to lose the money, they refrain from investing it in riskier assets and accept a so-called risk-free rate.  Risk-free rates are historically savings accounts, CD rates and the 10-year US Treasury.   Today, the US Treasury curve is very compressed, causing many to argue that treasuries and even short-term CDs involve a risk to principal should rates rise.  Hence, the only real risk free asset at the moment are cash accounts (savings or money market accounts) and those are only risk free when amounts over $250,000 per individual per insitution are spread across multiple banks or credit unions.

Against this backdrop, Duke Energy has sought to introduce something new for investors to stash cash. PremierNotes program are according to the Duke Energy website:

"... direct investments in new debt obligations of Duke Energy. Under the program, Duke Energy borrows directly from investors by issuing notes. In return, investors receive a competitive floating rate of interest that is very favorable compared to other cash alternatives like bank accounts, short term CDs and money market mutual funds."

Companies offering notes directly to investors is nothing new.[1] Duke is currently offering 1.51% on balances over $50,000 in its PremierNotes program.  Longer term, it commits to return 25 basis points above average money market fund rates.

Even though the rate on deposits over $50,000 is above any current savings or money market rate, most depositors will find that the slight increase in yield does not justify the risk involved in foregoing FDIC or NCUA insurance and relying entirely on Duke Energy’s ability to pay.   Duke’s junior unsubordinated debt is rated BBB-/Baa3 and its commercial paper rating is A-2/P-2.

Duke Energy, of course, is a great company.   It is the energy producer and distributor in the fastest growing region in the US.  Its equity is yielding 4.20% and while expensive on a historical P/E basis, it can be hedged in a manner in which you would receive about the same premium for your exposure to the company and still get all the upside.  For most, that is a far better way to play Duke.

 

[1] The idea of a place to stash cash that outranks savings and money market accounts and is secured by the credit rating of a major conglomerate, and not by the FDIC or NCUA is not all together new.  Companies such as GE, Ford and GM have occasionally targeted depositors and investors for their cash accounts with commercial paper programs.  Most companies discontinued these programs. GE still offers a program, called GE Capital Invest Direct or GE Capital Interest Plus, that today offers depositors 1.11% on deposits over $50,000; it is virtually unknown and should be completely avoided as depositors can get rates that are higher or as high from several FDIC and NCUA-insured institutions


Advantages and Disadvantages of Custodial Savings Accounts

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Custodial savings accounts are bank accounts set up by a parent for a child that can contain either savings accounts, CDs, or a combination of both. Using them as a savings vehicle present several advantages and disadvantages.

Custodial savings accounts are bank accounts set up by a parent for a child that can contain either savings accounts, CDs, or a combination of both. In fact, most general custodial accounts can also contain stocks and bonds. The money deposited into a custodial account becomes the property of the child but cannot be withdrawn without permission from the custodian until the child reaches adulthood (between 18-21 depending on the state).

Custodial accounts have several advantages and disadvantages as a savings vehicle for minors.

Advantages

  • Safety. Money placed into a custodial savings account cannot be withdrawn or used without the permission of the custodian.
  • Flexibility. The money, with custodian permission, can be withdrawn at any time and used for any reason. Money in 529 Plans can only be withdrawn for college expenses.
  • Potential tax advantages. Some minors may benefit from tax savings by placing their funds into a custodial account. Individuals under 18 (or 24 if a full-time student) do not need to pay tax on the first $850 in interest income generated from the account. The next $850 is taxed at the child’s income level, usually low. Any income over $1,700 is taxed at the custodian’s income, which can be substantially higher. Thus, if a child is generating significant income from the account, a custodian account may create a significant tax burden.  For interest income below $1,700, custodial accounts offer tax benefits.

Disadvantages

  • Money is Theirs. Once the money is given to the child in the custodian account, it is theirs. Legally, the money can only be used for expenses that benefit the child. And once they reach adulthood (18-21), they can spend it on whatever they want. The flexibility is a double-edged sword.
  • Tax Disadvantages. If the account generates more than $1,700 in investment income and the custodian has a high tax rate, the account will generate a significant tax bill for the minor. Over 30% of the income from the account could be taken in taxes. 529 Plans on the other hand allow contributions to grow tax deferred, and distributions used to pay for college come out federally tax-free.
  • Financial Aid Penalty. Money in a custodial account is counted as part of a student’s assets when they apply for financial aid.  This may negatively impact the aid application.

Eligibility & Contribution Rules

Any adult can set up a custodial savings account for a child under 18 years of age. There is no limit to the amount that can be contributed to these accounts but parents should be aware of the potential tax ramifications of depositing significant cash and generating sizable income from the account.

Transferability

The funds in a custodial account cannot be transferred to another child, unlike 529 plans and Coverdell ESA’s.

Where to Open

Many banks offer custodial savings account for minors under 18.


Savings and CD Rate Update - February 19, 2013

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New best online savings rate, savings and cd averages continue to fall, forecast continues to foresee rates falling for the next 10-16 months.

The big news this week is the downfall of the former heavyweight in the online savings arena. Salem Five Direct, which had the top online savings account paying 1.25% APY lowered their rate to 1.00% APY. That leaves AmTrust Direct with the top nationally available online savings rate at 1.05% APY.

Average rates continue their five year treck of heading down. Average one-year CD Rates dipped from .392% to .389% APY. Three year average CD rates dropped from .774% to .769% APY. Five year average CDs dropped to from 1.125% to 1.119% APY. Online savings accounts dropped from .728% to .720% APY.

Top rates Some top rates are:

Local banks and credit unions often offer better rates (especially for CDs) than online banks so be sure to check them out. View local CD rates in your area.

The chart below shows the trend in average rates since October 2012.

The difference in the rate of decline between online savings and CD rates can be viewed on the chart below, which shows the spread between online savings account rates and 12 month CDs. The spread still remains very elevated although it has come down a bit in recent weeks as online savings rates have declined a bit. On average, online savings account rates pay .331 percentage points more than 1 year CDs, up from .23 percentage points more at the beginning of last year.

General rate environment

The government and private sector released very little economic data this past week. One point is that the S&P 500 rose to its highest level in 5 years this week. Low interest rates have propelled the stock market for the past five years and the music has not stopped playing. I don't see the rising stock market as an indicator of higher interest rates ahead, but rather as a product of the Fed's low interest rate policy. For now I am leaving my forecast unchanged although many economists are lining up and predicting 2016 will be when the Fed starts raising rates (read this article in Bloomberg).

My outlook: Savings rates will continue to drift lower for the next 10-16 months before beginning to move higher. How high and how fast they move will depend on the government's ability to stop bickering and resolve their budget and borrowing disputes, the continuation of a recent economic uptick, technological advances, and the ability of Europe to put its woes behind it and resolve its fiscal problems.

My reasoning includes:

  • The Fed has committed to keeping rates exceptionally low as long as unemployment is above 6 1/2 percent. It currently stands at 7.9%. At the current rate of decline, it will take at least 2-3 years to get to 7.9%. If the economy picks up, it could get there sooner.
  • The economy has picked up a bit of steam in the last couple of quarters. But GDP growth of 1-2% will not be enough to quickly bring down the unemployment rate. I project steady but moderate economic growth of around 2.5% in 2013.
  • Bank are awash in cash from individuals and corporations and do not need more deposit dollars. Third quarter 2012 FDIC data showed banks had over $9 trillion in deposits, up from $8.5 trillion in the third quarter of 2011. Many banks are having trouble figuring out how to deploy their cash. Part of this is because of lending fears and credit quality and the other part is due to increased governmental oversight.
  • Demographic trends are unfavorable. Unfortunately, the United States has entered a demographic slide. As the large baby boom generation ages and retires, this puts a large strain on the country's productivity and spending. I believe that demographics is a general driver of economic development. A young population lifts all boats. An aging will leave quite a few boats stranded and make it difficult for the others. Japan and Europe have even worse demographic problems and their economies reflect that. As China's population ages, look for its growth to ebb. This demographic slide will be a factor for the next ten to twenty years, not stopping growth, but certainly acting as a headwind.
  • Government grid-lock. The debt ceiling threat has been raised for now but sequestration still looms. It's clear that these battles will continue to occur anytime a budget decision is needed until one philosophy prevails. At this point, a bi-partisan solution looks unlikely. The partisan bickering does little to establish confidence.
  • Local, state, and government cuts and tax increases are going to slow the economy. Even if sequestration is avoided, government at all levels is cutting back and raising taxes. At this point, it looks doubtful that businesses and the consumer will be able to make up the difference (especially with rising taxes).

Savings Accounts or CDs?

The data continues to show that opening a savings account is a better bet than a 1-3 year term CD and I expect this to hold through 2013. Online savings accounts have held the line over the past year while CD rates continue to fall.

So for now, here are my recommendations:

For money you want to keep liquid, go with online savings accounts. They offer better rates than 1-3 year CDs and have shown good rate stability over the past year.

For longer-term money, look to open 4-5 year CDs at local community banks. BestCashCow research has shown that community banks and credit unions offer the most competitive rates on longer-maturity CDs.

I believe this is the best and easiest strategy for keeping your cash liquid and maximizing your savings over the next year.

Make the best of a tough savings situation in 2013

Yields may be low in 2013 but a savvy saver can boost the return with no increase in rate by rate shopping. By shopping around, a saver can earn an extra half to full percentage point. On $100,000, that's $1,000 in extra cash per year. Remember, even in today's environment, there is competition for your cash.


Salem Five Lowers Top Online Savings Rate

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Salem Five Direct lowered their online savings account rate from 1.25% to 1.00% APY. It had been the highest online savings rate in the country.

For several months, Salem Five Direct had been offering the top online savings rate in the US at 1.25%.

For those that did not open an account previously, the rate has now been lowered to 1%.  

Those who had previously opened an account received a note explaining that their rate would still be 1.25%, but cited an  “interest rate environment in constant flux” and made no commitments on how long the rate would hold.

The 1% rate for new depositors remains among the most competitive for online savings accounts.   In addition, the bank continues to offer the rate to a maximum deposit of $500,000 for those depositors who are comfortable relying on the Massachusetts DIF insurance for deposits over the $250,000 FDIC limit.   BestCashCow covered DIF insurance several years ago and it is still true that no depositor covered by the fund has ever lost money.  

There are plusses and minuses to a Salem Five Direct Online Savings Account. Besides the attractive rate, the account has some nice security features including required text coding and callbacks to finalize money transfers in and out. On the negative side, the bank has some restrictive limits on money movement, limiting outbound ACH transfers to $2,000 per day and charging a $20 fee per transfer.  Inbound ACH transfers are limited to $5,000 per day and $25,000 per month.  The bank also assesses fees to receive inbound wire transfers, as well as to execute outbound ones.

The rate is still attractive but many savers might find the transfer limits and fees to be a non-starter.