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.
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.
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 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.