Bank 'repos' draw investors despite lack of insurance

Would you put several thousand dollars in your bank -- even if it were not covered by deposit insurance?

A lot of people apparently would, and are. They are buying retail repurchase agreements, or ''repos,'' from their local banks or savings and loan institutions.

Repos are sold in denominations of $1,000 or more and held for 89 days or less. When a repo is purchased, the bank agrees to buy it back at the end of a certain period and pay so much interest. These days, that annualized interest is running from 11 to over 13 percent, depending on the size of the repo and how long it is held.

Unlike ordinary deposits, repos are actually investments in the bank, so there is no deposit insurance from the Federal Deposit Insurance Corporation (FDIC) or the Federal Savings and Loan Insurance Corporation (FSLIC).

Despite this lack of insurance, people have bought more than $17 billion worth of repos. Most of this money has come in over the last year, when repos have been available to the general public. Part of the growth is due to higher interest rates. Ever since banks started losing deposits to the money market mutual funds, they have been looking for instruments to get customers to keep their money in the bank's vaults. Repos allow them to offer competitive rates on every dollar invested.

A second reason is marketing. Another effect of the banks' battle with money funds has been much more aggressive -- and occasionally overstated -- advertising. A newspaper ad for a savings bank in Boston, for instance, carries the headline: ''Get Rich Quick!''

Many people thinking about buying repos, however, are less worried about getting rich than they are about safety. Banking regulators have guidelines for repos that include a requirement that every dollar's worth of repo must be backed by an equal amount of securities from the US government or its agencies. Having this collateral is known as giving customers a ''perfected interest.''

In some cases, banks ''overcollateralize,'' and give extra coverage, perhaps 110 percent. This protects every $100 in repos with $110 in securities.

Theoretically, this means if the bank fails, customers holding repos would be near the head of the line when it came time to settle the bank's debts. They would have that repo, and if the bank did not pay on it, the customers could take the government security and sell it to get their money back. They would probably lose some of the interest they expected, but the prinicpal would be safe.

Theory, however, has not yet faced the challenge of reality. According to an FDIC official, there have been no court cases to test the standing of repo customers. It is possible that a bank could fail and the value of the collateral would be less than the value of its outstanding repos.

If you are thinking of buying a repo, there are several things that can be done to reduce the risk. You may require the banker to answer more questions than he is used to, but if he wants your business, he will answer your questions. After all, now you are not just a depositor, you are an investor.

First, ask to see the bank's financial statement. A bank should have enough capital to protect depositors and investors against risks taken by management. Not too long ago, most conservative banks had a 1-to-10 ratio, or smaller. This meant they had $1 in capital for each $10 in assets. Many small banks still have this ratio.

Some of the larger banks, however, have taken on more debt and have much higher capital ratios, sometimes as high as 1-to-20 or 1-to-24. You may be more comfortable with a bank having a lower ratio.

The banker should also provide statements showing the repos are fully backed by government securities and that this backing is continually kept up to date as new repos are sold and the bank's interest obligation increases.

You may want to start out small, buy a minimum-sized repo, and see how the bank does with it. If you want to invest a lot of money in repos, it would probably be a good idea to use more than one bank.

This diversification should apply to your investments in general; repos should be no more than just one part of a variety of investments, carrying a variety of risks.

If you would like a question considered for publication in this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.