What it means
The structure combines two familiar things. It is a term deposit that pays a stated rate for a stated number of years, with a call option written in favour of the bank rather than the saver.
Calls typically become available after an initial protected period, often six months or a year, and then on set dates such as every quarter. If the bank calls, the depositor receives the full principal plus interest earned to that date, with no penalty on either side.
The bank's incentive is exactly the same as a bond issuer's. If market rates fall, continuing to pay 5.25% on your deposit becomes expensive relative to what it could pay new depositors, so it calls the deposit and refunds you.
That means the outcome is asymmetric in a way many savers miss. If rates rise, the bank happily leaves the deposit outstanding and you are stuck earning below market for years, while if rates fall the deposit is called and you must reinvest at the new lower rate.
Callable certificates are also often longer dated than the buyer expects, sometimes ten or fifteen years. Selling before maturity usually means finding a secondary market buyer at whatever price they will pay, which can be well below face value if rates have risen.
In practice
Real-world examples.
Example
A saver buys a $250,000 callable certificate at 5.4% rather than a plain one at 4.8%, attracted by the extra 0.6%. The bank calls it after eleven months when policy rates drop, and the best replacement rate available is 3.9%.
Example
A small business places a $180,000 reserve into a seven year callable certificate. Two years later it needs the cash for an equipment purchase, discovers the bank has no obligation to return the money early, and has to sell the certificate on the secondary market at 96% of face value.
Example
A retired couple ladder their savings across four certificates, deliberately mixing two callable and two non-callable. When both callable certificates are redeemed in the same year, the non-callable ones continue paying their original rates and keep overall income from falling too sharply.
Formula
Calculation
Total interest if held = principal x rate x years
Total interest if called = interest to the call date + interest on reinvested proceeds
Compare a $100,000 five year callable certificate paying 5.25% with a $100,000 five year non-callable certificate paying 4.60%, using simple interest for clarity. The callable version pays $100,000 x 5.25% = $5,250 a year, against $100,000 x 4.60% = $4,600, so the extra yield is worth $650 a year.
If nothing happens and the callable certificate runs its full term, the depositor earns 5 x $5,250 = $26,250 against 5 x $4,600 = $23,000, a gain of $3,250.
Now assume rates fall and the bank calls after one year, with the proceeds reinvested at 3.50%, or $3,500 a year. The callable route earns $5,250 + (4 x $3,500) = $5,250 + $14,000 = $19,250, against $23,000 for the non-callable certificate. The depositor ends up $23,000 - $19,250 = $3,750 worse off, which is the cost of the option handed to the bank.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Wrenfield Community Bank, an invented deposit taker, offered a ten year callable certificate at 5.60% when comparable non-callable products paid 4.75%. A fictional customer, a small charitable trust, placed $300,000 in it to fund an annual bursary of about $16,800.
For two years the arrangement worked exactly as hoped, paying $300,000 x 5.60% = $16,800 a year. In year three, market rates fell and Wrenfield exercised its call on the scheduled date, returning the $300,000 in full with interest accrued to that day.
The trust reinvested at the prevailing 3.6%, producing $300,000 x 3.6% = $10,800 a year and forcing the bursary to be cut by $6,000. Had the trustees originally taken the 4.75% non-callable product, they would have received $300,000 x 4.75% = $14,250 a year for the whole ten years, which is $2,550 a year less at the start but far more dependable over the full term.
Watch out
Common mistakes.
- Comparing a callable certificate with an ordinary one on headline rate alone, ignoring the call option handed to the bank.
- Assuming the depositor can also end the arrangement early, when only the bank holds that right.
- Overlooking the maturity date and buying a fifteen year product on the assumption that it will certainly be called within a year or two.
Questions
People also ask.
Is my money still protected by deposit insurance?
Yes, a callable certificate is an ordinary bank deposit for insurance purposes, so the usual per depositor limits and rules apply.
Do I lose interest if the bank calls the certificate?
No, you receive all interest earned up to the call date, but you lose the future interest you had expected for the remaining term.
Who should consider a callable certificate of deposit?
Someone who understands the option they are selling, has other income sources that are not exposed to falling rates, and would be comfortable holding the deposit to its full stated maturity.
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