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4000 - Advisory Opinions
Questions regarding deposit insurance coverage of the interest on
a CD when interest is based on the Consumer Price Index
FDIC--04--05 August 13, 2004 Joseph A. DiNuzzo, Counsel
This is in response to your letter concerning the deposit insurance
coverage of the interest on a certificate of deposit ("CD") for
which interest is based on the Consumer Price Index ("CPI"). In
particular, your question is whether the FDIC would insure the interest
on the deposit based upon the increase, if any, in the CPI as of the
date the applicable FDIC-insured institution failed as if the failure
date were the CD maturity date. As we discussed at our meeting on July
15, 2004, and as explained below, the answer is that the FDIC would not
insure the "Additional Interest" on such a CD until the
deposit's actual maturity date.
The Product
As indicated in your letter, the CD pays interest with reference to
the CPI. On the date the CD is issued a base CPI is established for the
CD ("Index Base"). During the term of the CD, the depositor's
principal amount is adjusted to reflect increases or decreases in the
Index Base. This adjusted principal amount is referred to as the
"Inflation Adjusted Base" and is used solely to calculate
interest on the CD. The Inflation Adjusted Base does not reflect an
increase or decrease in the actual principal amount of the CD.
Depositors earn interest on the CD in two ways. First, the CD has a
fixed rate of interest with payment made periodically, typically
semiannually ("Periodic Interest"). On each interest payment
date, the depositor receives interest equal to the fixed interest as
applied to the Inflation Adjusted Base. Second, at maturity the
depositor is paid interest equal to the positive difference between the
Inflation Adjusted Base and the CD's principal amount ("Additional
Interest"). The CPS used in determining the interest on the CD is on
a "look-back" basis, using the CPI for the third preceding month.
Under all circumstances the depositor would receive the entire
principal amount of the CD at maturity.
Issue and Request
Section 330.3(i) of the FDIC's regulations
(12 C.F.R. 330.3(i))
("Section 330.3(i)") is entitled "[d]etermination of the
amount of a deposit." You note that the FDIC could ascertain the
CD's Inflation Adjusted Base on an institution's failure date. And,
having ascertained the Inflation Adjusted Base, the FDIC could
determine the amount of Periodic Interest that had accrued, as well as
the amount of Additional Interest that would be paid "if the deposit
had matured on that date." Hence, you maintain that under Section
330.3(i) the Periodic Interest and the Additional Interest on the
CPI-indexed CD would be eligible for insurance coverage as of an
institution's failure date. You ask that we confirm your analysis and
conclusion.
Discussion
The fundamental issue here is the definition of the "amount of a
deposit" for deposit insurance purposes. The FDIC has addressed this
issue in the past by applying the general rule that an insurable
deposit is comprised of the principal amount of a deposit plus the
ascertainable, accrued interest as of the date of the institution
failure. In a 2000 Legal Division opinion we considered a ten-year CD
with a rate of interest based on the S&P 500 Index, with no guaranteed
interest rate and no interest payable until
maturity. 1
The letter noted that in the past the FDIC had reviewed CDs with
indexed interest rates and had concluded that the CDs would be eligible
for deposit insurance as to the principal and the guaranteed rate of
interest, but that, in accordance with our regulations,
"contingent" interest would not be eligible for deposit
insurance. The letter stated, "[h]ere the CD has no
{{10-29-04 p.4984.95}}ascertainable interest until the
maturity date and no guaranteed interest rate. Hence, if the issuing
institution failed prior to the CD maturity date, there would be no
accrued or ascertainable interest earned on the deposit and, thus, the
deposit insurance would be limited to the principal amount of the
CD."
With the CPI-Indexed CD the issue is not whether the Periodic
Interest would be insured. That interest would be ascertainable and
accrued as of the date of the failure; thus, it would be insurable. The
issue is whether the Additional Interest would be insurable. We agree
with your position that the Additional Interest would be ascertainable
if and when the institution failed. That's because the
"look-back" provision would identify a pre-existing CPI to apply
to determine the amount of the Additional Interest. But the Additional
Interest would be contingent and would not be accrued as of
the date of the bank failure, unless the failure happened to coincide
with the actual CD maturity date. Because it is not accrued on that
date (i.e., the depositor would have no entitlement to that
interest as of the date of the institution failure) it is not
insurable. More basically, the institution and the depositor agreed
that the Additional Interest would be paid upon the actual CD maturity
date based on the applicable CPI index at that time (applying the
"look-back" provision). No such Additional Interest would exist
at the time of the institution failure because the CD never reached the
contracted-for maturity date. Thus, the FDIC would insure the principal
amount of the deposit plus the ascertainable interest accrued as of the
institution's failure date, but the Additional Interest that might
have been earned at the actual maturity date would not be eligible for
deposit insurance. 2
Although we believe the FDIC's view on the insurability of
contingent interest have been clear and consistent, the language of
Section 330.3(i) is not as straightforward as it could be. That
provision reads:The amount of a deposit is the balance of principal and interest
unconditionally credited to the deposit account as of the date of
default of the insured depository institution, plus the ascertainable
amount of interest to that date, accrued at the contract
rate . . . , which the insured depository institution in default
would have paid if the deposit had matured on that date and the insured
depository institution had not failed. . . .
Your interpretation of this language is that we should consider the
institution's failure date to be the CD maturity date and calculate
the Additional Interest accordingly. Consistent with the position
explained above, we read this provision as defining the "amount of a
deposit" to be the principal amount of the CD plus the
ascertainable, accrued interest as of the institution failure
date. 3
We believe this interpretation is more consistent with the policy
objective of providing deposit insurance coverage based on the
depositor's legal entitlement as of the date of the institution
failure. That entitlement is defined in the deposit contract between
the institution and the depositor. As noted, under the CPI-Indexed CD
the depositor is entitled to no Additional Interest until the actual
maturity date of the CD. Thus, under Section 330.3(i), prior to the
actual CD maturity date, we would consider the Additional Interest to
be contingent interest and, hence, not part of the
"amount of [the] deposit" for deposit insurance purposes.
I hope this letter is fully responsive to your inquiry. Feel free to
contact me with any additional questions or
comments.
1Letter of August 21, 2000, to the Honorable Sharon G. Bias,
Commissioner of Banking, State of West Virginia, from Joseph A.
DiNuzzo, Counsel. Go Back to Text
2From a policy perspective it is also relevant that as of the
institution's failure date the Additional Interest would not have been
included in the institution's "assessment base" for purposes of
determining what, if any, deposit insurance assessments the institution
owed the FDIC under section 327 of the FDIC's regulations (12 C.F.R.
327). Go Back to Text
3The rulemaking history of Section 330.3(i) does not provide
determinative guidance on this issue. Go Back to Text
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