One of the concerns with long-term CDs is that the bank won't honor the terms of the CD. An important term is the right for an early withdrawal with a penalty specified in the disclosure when the CD was opened. The fear is that if rates shoot up in the next few years, banks will take steps to prevent early withdrawals by increasing the penalties or by just refusing the withdrawal requests.
Another important term is the maturity date. Unless the CD is callable, you expect that the CD will earn the specified interest rate until the maturity date as specified when the CD was opened. The only exception has been when a bank fails. By law the acquiring bank may decide to close the CD early. It looks like that's not the only exception. There has been a recent case in which a bank broke this contractual agreement. This is described in this blog post at Jumbo CD Investments.
Main Street Bank in Kingwood, TX used a clause in their disclosure to allow the early closures of the CDs. They claimed that they are being required by a consent order with the FDIC and Texas regulators to meet certain capital requirements, and this is the reason for the early CD closures. Here's the clause from the bank's disclosure:
Amendments and Termination - From time to time we may amend any term of this agreement upon giving you reasonable notice in writing or by any other method permitted by law, including, in appropriate circumstances, posting notice in our building. We may also close this account at any time upon reasonable notice to you and tender of the account balance personally or by mail. Notice from us to any one of you is notice to all of you.
We've seen some other banks include a similar clause in their disclosures which essentially turns the CDs into callable CDs, but this is the first time I've seen a bank make use of this clause to actually close the CDs early.
My contact at Jumbo CD Investments said they tried to work with the bank's CFO to see if the bank would at least honor some of the remaining interest they owed to the depositors. They suggested that the bank at least pay the depositors the difference in cost of what they expected to be earning and what rates they can currently receive now. The bank decided against this and is only paying interest up to January 3, 2011.
Not only did the bank decide to close the CDs, they did so on Christmas Eve. They sent out the letters on December 24th, and at the same time they returned the funds via wire transfer without any other warning. This appears to be a clear violation of Regulation DD:
§ 230.5 Subsequent disclosures.
(a) Change in terms--(1) Advance notice required. A depository institution shall give advance notice to affected consumers of any change in a term required to be disclosed under § 230.4(b) of this part if the change may reduce the annual percentage yield or adversely affect the consumer. The notice shall include the effective date of the change. The notice shall be mailed or delivered at least 30 calendar days before the effective date of the change.
Another disturbing issue of this is that the staff at Jumbo CD Investments isn't getting any help from the FDIC. Here's an excerpt from their blog post:
And shame on the FDIC for not doing their duty (and believe me this isn’t the first time) to protect depositors from unscrupulous banks that hide behind small print.
This case strengthens the concerns of many readers who fear these blanket clauses in the CD disclosures could be used by banks and credit unions to the detriment of the CD account holders. This concern was described in my blog post on the risks and benefits of long-term CDs and in this forum thread on Fort Knox FCU's early withdrawal penalty.
One interesting thing to note about Main Street Bank is that they appear financially healthy. I was disappointed to see that we gave Main Street Bank an overall health score of 4 out of 5 with a Texas Ratio of 5.01% based on September 2010 data. However, we're not alone. Bankrate.com gave them the top rating of 5 out of 5 stars. BauerFinancial won at the ratings in this case. They gave the bank a 2 out of 5 star rating. Calculated Risk Blog's unofficial problem bank list did list Main Street and their July 2010 FDIC consent order. I'm sure most of the CDs were opened before July, so this shows that even if a bank appears financially healthy, it doesn't mean you won't have to worry about the bank doing what Main Street Bank did.
In my opinion the regulations and the regulators are inadequate in the protection of depositors. There have been a lot of new regulations this year to protect borrowers, but nothing for savers. There needs to be regulations that ensure that banks can't use overly broad disclosure clauses to make major changes to CDs to the detriment of the CD account holders. It's bad enough that savers are having to live with these record low interest rates. We shouldn't have to worry about banks cheating us on our CDs.