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Early Withdrawal Bonus? New CDs Will Give Savers More Options

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How would you design a better CD? You can't design it to be better for just the depositor. It has to be a win-win for both the depositor and the bank. That's what Neil Stanley has been working on. In his article at Banking Strategies, From Commoditized to Customized Deposits, he describes ways CDs can be improved so that banks can attract and retain depositors. He warns banks that CDs are declining in popularity, and this decline isn't just due to the low interest rate environment. Offering more customized CDs will allow banks to attract more deposits without offering the highest interest rates.

One interesting feature Stanley proposes is an early withdrawal that would be similar to the gain/loss an investor would experience when selling a bond or a brokered CD:

* Have the option to withdraw early from the time deposit with all principal and interest and a “bond-like” gain when interest rates have dropped

This feature has already been implemented in a direct CD at one Iowa bank. Treynor State Bank offers a CD that is called CDtwo. Here's how the bank describes the early withdrawal penalty/bonus:

After the first 7 days, the penalty/bonus is determined by the Replacement Fee. The Replacement Fee is an estimate of the interest cost to us if we were to replace a CD that is withdrawn early with another deposit having a term that is comparable to the remaining term of the original CD. 18 month - 60 month terms available. If interest rates have risen, then the cost of the new deposit will be higher. If interest rates have fallen, then the cost of the new deposit will be lower.

One thing nice about this feature is that the bank is upfront about the early withdrawal. There's no assumption that the depositor will hold deposits until maturity. So depositors shouldn't have to worry about a bank refusing an early withdrawal request or surprising depositors by changing the costs of early withdrawal on existing CDs. Two credit unions have already increased early withdrawal penalties on existing CDs. The worry is that we may see more of these actions when interest rates go up.

Another nice thing about this feature is that it could provide a bonus for an early withdrawal when rates have fallen. This is similar to what some banks have done in the last few years by temporarily waiving early withdrawal penalties on existing CDs. In these cases, the banks are hoping to close the "expensive" CDs. For depositors in this case, the only reason you would want an early closure would be if you have an immediate need for the money.

The downside with this feature that I see is that the replacement fee is more complicated than the typical early withdrawal penalty. The typical EWP is often just 6 months of interest on the amount withdrawn. That's easy to understand, and it's easy to calculate the consequences of early withdrawals.

What do you think of this early withdrawal feature? And what CD features would you like to see from banks and credit unions?

Edit 4/8/13: Removed "Refinance conventional CDs" bullet.


  Tags: CD rates

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Comments
22 Comments.
Comment #1 by Anonymous posted on
Anonymous
The banks will take your money, no matter how you call it. Only the depositors loose every time.

When you get 1 or 2% interest on your money, you already lost part of you principle due to higher inflation rate and when you include penalties, you have lost twice.

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Comment #2 by Anonymous posted on
Anonymous
#1.............I'm assuming that no one is holding a gun on you & forcing you to deposit money in the bank. Apart from my regular checking account, I haven't had any FDIC accounts for over 10 years. You are correct, in that people who do have money sitting around earning 1-2% will "loose" to inflation................& are by extension true "loosers". :)

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Comment #3 by lou posted on
lou
I actually hope that banks and credit unions do not adopt this practice. The one advantage of CDs over bonds and other fixed income investments is that the principal balance will not go down if interest rates go up. Since there is no other place for interest rates to go than up, this particular benefit would be negated. If one is willing to assume interest rate risk, there is probably no reason to purchase CDs.

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Comment #4 by Anonymous posted on
Anonymous
lou.......I have no idea when interest rates will go up, but I find it interesting that people for the past 5-6 years have been suggesting that interest rates have nowhere else to go but up...............just like you just finished suggesting. And yet, here we still are. :)

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Comment #5 by lou posted on
lou
#4, yeah, it may never happen. We could be experiencing a 20-year Japanese deflationary liqiudity squeeze, however,  the monetary and fiscal policies we have pursued for the last 5 years might also trigger inflation and higher rates at some point . Who knows!

I spent my entire career in the real estate finance business, and I was warning people about a real estate bubble 3 years before it happened. I knew that the correlation between housing payments and median income was not making any sense and that the double digit price increases could not continue. Very few people took me seriously and there were times I seriously doubted myself and everything i had learned about the industry. Eventually, I was vindicated but it took a while. I think the same situation exists today. Someday we will pay the piper for our profligacy.

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Comment #6 by Anonymous posted on
Anonymous
To Lou,

if inflation goes up even more, the reciprocity of higher interest rate will always lag the purchasing power of your savings. So, you loose twice again.

Bernanke can manipulate the value of the dollar to his likings and our savings will be destroyed with higher inflation. That is what he is doing now, printing money and keeps low interest rates with hidden inflation.

Dollar looses the purchasing power without true compensation for our savings. They will continue for long term or until the dollar will colapse of it worthless denomination.

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Comment #7 by Anonymous posted on
Anonymous
The Federal Reserve will make their zero interest rate policy permanent. The equity markets, magabanks and government are all dependent on it. Even if the unemployment rate goes down to 6.5%, which really won't occur, the Fed will not raise rates. Consumer inflation is at 9% versus the government's claimed 2% because figures can be manipulated to justify anything. The current deposit rates are about the best you will get going forward. Certificates of deposit are just a means of watching the purchasing power of your money erode due to inflation and currency devaluation measures.

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Comment #8 by Anonymous posted on
Anonymous
CD's, savings accounts, etc are over.....done. Interest rates will never again go up.....at least on these products. Time for you people to wake up and get some %^%^$ !!!  Look at other options. The real risk is putting your money in anything that pays 1% !!!!!!  Look into dividend stocks,peer lending,etc.

3
Comment #9 by Anonymous posted on
Anonymous
Finally, people talking some sense. Although I don't agree with the "interest rates will NEVER go up again" camp.............until they do increase to the extent where they provide a significant return above inflation, it makes no sense whatsoever to put money in FDIC deposits. Who knows how many years down the road that is..............but it ain't going to be this year, or next year. 

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Comment #10 by Neil Stanley (anonymous) posted on
Neil Stanley
I truly appreciate the frustration of low interest rates to savers.  But, to say that no one should invest their life savings in conservative investments today because the rates are too low reminds me of the quote attributed to Yogi Berra "Nobody goes there anymore; it's too crowded."  The buyers and sellers of the bond market set rates.  The unfortunate thing for conventional CD holders has been that they are seeing eroding yields.  However, you might be surprised at the net yields some TS Bank customers have experienced in CDtwo.  Because the value of the CD goes up when interest rates decline one particular CD holder experienced an 8.96% holding period yield on a CD issued in 2011.  You can still dismiss the idea.  But, I wanted to inject some pertinent facts into the discussion.  When you look back at bond yields and bond fund yields over the past five years, note that the enhanced version of FDIC insured CDs could create those types of results too. Regards,  Neil Stanley

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Comment #11 by lou posted on
lou
Neil, are you referring to brokerage CDs that you can sell on the secondary market? I never heard of TS Bank. What is the full name of the bank? Can you be more specific regarding the terms of the CD that returned 8.96% to a particular CD holder. One problem with brokerage CDs is that they can be very difficult to sell on the secondary market in that they don't trade very often.

1
Comment #12 by lou posted on
lou
Sorry Neil, I just re-read the article and I can see you're referring to Treynor State Bank that has a CD that behaves like a brokerage CD. They don't show the rate or term for this CD on their website. Do you know what they are offering toay?

1
Comment #13 by Neil Stanley (anonymous) posted on
Neil Stanley
Lou, a CDtwo is redeemed from the bank that issued it.  The bank calculates the replacement cost and pays you a fair value.  If interest rates go down they can replace your funds at a lower cost, so they can pay you more than your principal and interest.  Although this is new to banks, it is really quite simple.  There are no third-parties involved therefore, no value leaks away via commissions and you don't have to look for someone to make a market for your CD.

1
Comment #14 by lou posted on
lou
What rate are they offering for the 5 year CDtwo?

1
Comment #15 by Neil Stanley (anonymous) posted on
Neil Stanley
Lou, Sorry for the delay. I had some things to attend to before I could respond to your question. They offer the same rate on CDtwo as on their conventional CD. I believe that the current APY is 1.10% on a 5-year. That may not seem attractive to you, but keep in mind that if rates don't rise, you could hold the 60-month for a short term like 3 months and redeem it with a 1.10% holding period yield giving you a long-term yield on a short-term investment.

 

You asked in an earlier comment about the specifics of the 8.96% yield.  That CD had a 2.40% rate, but was redeemed with a gain that produced the 8.96% yield when the gain was added to the principal and interest at redemption.

 

I urge you to consider that the CDtwo is structured like the bonds that the banks buy for themselves and the redemption option is solely the depositors.  The bank retains no special value for themselves with this.  It is really designed to pass along the full risk and value of long-term investing.  With a conventional CD, banks don't pass along the full value including price appreciation.

2
Comment #16 by Neil Stanley (anonymous) posted on
Neil Stanley
I think it may be helpful to also note that the simple average of rates paid by U.S. depository institutions as reported by the FDIC for 60-month CDs was reported as of 4/1/2013 at .77%.

 

1
Comment #17 by lou posted on
lou
'The Replacement Fee is an estimate of the interest cost to us if we were to replace a CD that is withdrawn early with another deposit having a term that is comparable to the remaining term of the original CD. 18 month - 60 month terms available. "

Neil, with all due respect, this is quite different than what happens when you sell your bond on the secondary market through a broker. In that situation your bond is priced according to market rates as determined by what buyers and sellers are willing to transact for that bond on the day you decide to sell. In this situation, you are at the mercy of the bank who will ESTIMATE their interest cost to replace your CD. Banks can pay rates that are higher or lower than the market rate, so to have rely upon their ESTIMATE of their interest cost or whatever they decide to pay for their CDs on any given day. In my view, this gives them too much control of the process in determining the value of your CD. In effect, they decide what the market is.

1
Comment #18 by Neil Stanley (anonymous) posted on
Neil Stanley
Lou, I find it interesting that what you express concern over is what some bankers most worry about.  They are concerned that it forces transparency.

I cannot overstate my appreciation for your concern.  We know that the “devil is often in the details”.  But, keep in mind that the bank offering to redeem the certificate will disclose the replacement rate to the depositor.  As you suggest, the bank that overstates their replacement cost has just made an over-the-market offer to the depositor who could respond this way…”Given that your replacement cost today on my CD is X%, I find that attractive.  Instead of redeeming my existing CDtwo, I will open another CD for the remaining term of this one at that rate!”  I think you can see the fairness inherent in the system where the bank has to see themselves as both issuer and redeemer at the rates they quote.  Therein lies your buyers and sellers perspective.

1
Comment #19 by lou posted on
lou
Thanks Neil for the explanation. I am assuming the replacement cost is based on the advertised rate for their current CDs, so the process is transparent for the bank customer.

I don't find this deal attractive because If I am going to assume the risk of not knowing what my CD is worth prior to maturity, then i would need a better rate to compensate for the lack of certainty. If anything the risk of interest rates going up is far greater than they are of going down. The investor is assuming far greater risk than the bank. 1.10% is way too low.  Currently, you can find 5 year CDs at around 2% with some other credit unions. If Treynor bank wants my business, they would have to increase their rates far more than what they are offering today.

1
Comment #20 by Neil Stanley (anonymous) posted on
Neil Stanley
Lou, I greatly appreciate your willingness to dialogue with me!  I understand and agree that more is better than less regarding APY when all else is the same.  Conventional CDs and CDtwo both calculate fixed interest rates to maturity.  So both versions of CDs will be worth the contractual value at maturity.  The market value CD does not diminish the fixed rate results.  A conventional CD has a simple interest penalty.   Here is my question...If you think rates will not be rising anytime soon and you could get a 2% long term CD with a 6-month penalty or a 2% long term CD with a market value redemption that would mean a gain in a falling interest rate environment which would you take?  Why?
 

1
Comment #21 by lou posted on
lou
Neil, in all honesty, considering the ultra low rate environment we are in, i would take the CD with the 6 month penalty. Looking at this as objectively as I can, the odds of rates falling from these levels are less than rates rising. Although if Treynor was offering a 2% rate I might think differently, because there is a possibility the 2% rate may not go up for a long time. However, at 1.10%, I doubt their rates are going down much from this level. I just don't see much upside for the investor in this scenario, particularly when there are much more attractive rates being offered elsewhere.

2
Comment #22 by Neil Stanley (anonymous) posted on
Neil Stanley
Thanks Lou,

Every depositor should always consider both price and structure.  I don't dismiss anyone's assessment today that the current yields are low and that rates might rise.  My goal has been to enhance the structures available to depositors regardless of price.   With CDtwo we have developed the ability for bank customers to buy the same kind of structure the banks themselves buy.  This market value time deposit structure will be available not just when rates are low.  Keep in mind that one depositor netted over 8% yield on a CD with a 2.4% interest rate.  Over my professional career 2.4% is a low rate, but I tend to feel pretty favorable about 8% yields.  Therefore, I hope you don't categorically dismiss the structure that can deliver this performance. 

In addition to the creation of CDtwo which benefits the depositor in steady and falling rates, we have created the most efficient way to refinance CDs in a rising rate environment.  So, I appreciate that the depositor's rate expectations should play a role in these decisions.  What I have been striving to note here is that the conventional CD is decidedly inferior in a steady or falling rate environment when the penalties used are not based on an economic foundation.  Best regards, Neil

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