Investment Issues for Homeowner Associations – FDIC Insurance, CDARS, Laddering and Policies

Associations should be well-versed in how to invest excess funds. Homeowner associations include condominiums (Ch. 514B), planned community associations (Ch. 421J) and time-sharing plans (Ch. 514E). The only definitive guide to the investment of excess association funds is found in Ch. 514B-149, Association fiscal matters; handling and disbursement of funds. However, as a matter of policy and prudence all homeowner associations would do well to use the guidelines provided for condominiums.

Currently, the national average for a 1-year CD rate is a paltry 0.28%. Some associations may be tempted to purchase bonds or equities that can return as much as 5% – 6% in many cases. This is ill advised as the primary goal of homeowner associations should be the preservation of capital and not the maximization of income from investments.

All funds collected by an association, or by a managing agent for any association, shall be:

“Deposited in a financial institution, including a federal or community credit union, located in the State, pursuant to a resolution adopted by the board, and whose deposits are insured by an agency of the United States government…”

The FDIC website at www.fdic.gov states that:

“The FDIC is an independent agency of the United States government that protects the funds depositors place in banks and savings associations. FDIC insurance is backed by the full faith and credit of the United States government. Since the FDIC was established in 1933, no depositor has lost a penny of FDIC-insured funds.

FDIC insurance covers all deposit accounts, including:

• Checking accounts
• Savings accounts
• Money market deposit accounts
• Certificates of deposit

FDIC insurance does not cover other financial products and services that banks may offer, such as stocks, bonds, mutual funds, life insurance policies, annuities or securities.

The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.

As it applies to homeowner associations, the FDIC limit of $250,000 is per Taxpayer Identification Number. In other words, an association should not have more than $250,000 in any one FDIC insured bank, including branches of the same bank. Significant amounts in excess of the $250,000 FDIC limit would likely be noted in the independent auditor’s report.

The law for condominiums is very clear when it comes to the investment of association funds:

All funds collected by an association, or by a managing agent for any association, shall be invested only in:

• Deposits, investment certificates, savings accounts, and certificates of deposit;
• Obligations of the United States government, the State of Hawaii, or their respective agencies;
• Mutual funds comprised solely of investments in the obligations of the United States government, the State of Hawaii, or their respective agencies; or
• Certificates of deposit issued through the Certificate of Deposit Account Registry Service (CDARS).

The law, as written for condominiums, places an emphasis on preservation on capital.

A managing agent or board shall not, by oral instructions over the telephone, transfer association funds between accounts, including but not limited to the general operating account and reserve fund account.

The CDARS website, cdars.com, contains the following statement:

“CDARS® – the Certificate of Deposit Account Registry Service® – is the most convenient way to access FDIC insurance on multi-million-dollar CD deposits and to earn CD-level rates, which often compare favorably to Treasuries and money market mutual funds.”

Prior to the CDARS program, large associations with many millions of dollars in operating and replacement reserves were in a dilemma as to how to invest the cash because the FDIC insurance 1imit is a maximum of $250,000. For example, if an association had, say, $5 million in investable cash, it would be forced to locate 20 FDIC insured banks. If the association had $10 million, 40 banks would be needed.. Hawaii doesn’t have 40 banks that are FDIC insured.

There are thousands of banks, many of them located in Hawaii, that are members of the CDARS network. This means that one bank will distribute the investments across many different member banks with no single CD exceeding $250,000. Each CD earns one interest rate. The association receives just one statement summarizing its CD holdings.

Laddering is a risk management tool used when interest rates are expected to go up. Several years of Quantitative Easing by the Federal Reserve has resulted in interest rates that are near zero. Beginning in 2015, the Federal Reserve raised the discount rate by 25 basis points. Most economists predict that the Federal Reserve will continue to raise the discount rate. This will result in higher interest rates and earnings for the consumer. When this will occur is anybody’s guess.

From an association perspective, laddering is a viable options and protects the association in the long-term. Here’s how it works:

Assume that an association has, say, $1 million to invest. Instead of investing the entire million dollars in a single 1-year CD, we would split it into four equal amount of $250,000 each and purchase four CD’s with maturity dates of 3-months, 6-months, 9-months and 1- year. The result is that one CD will mature every 3 months and would be re-invested for 1- year.

Directors have a fiduciary duty to their respective associations. One aspect of this duty is to know the law as it applies to homeowner associations – ignorance of the law, even if it is unintentional, is not an excuse.

When it comes to investment decisions, a common sense approach may include the following:

• Adopt an investment policy that emphasizes preservation of capital.
• Have the Treasurer and/or Finance committee review the investment accounts at least once a year.
• Require that all association accounts, i.e. checking, savings, money market, investment, have at least two directors on the signature card.
• Limit investment maturity dates not to exceed 1 year. This is especially true in a rising interest rate environment.

Please feel free to contact us if you have any questions or comments concerning this article.

Prepared by Ronald A. Kawahara, CPA, CVA, CPM, PCAM

President, Destination Maui, Inc.

220 Imi Kala St., Suite 104

Wailuku, Maui, Hawaii 96761

(808) 244-9021

rak@mauicpa.net