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Callable CDs offer higher rates, risk

If interest rates drop, banks can redeem the CDs early, or call them, leaving investors to reinvest at lower rates. The call provisions always favor banks.


© St. Petersburg Times,
published October 21, 2001

When other retirees complained about falling interest rates on their investments, Joseph and Marverine Cappiello thought they didn't have to worry. The Inverness couple thought they had a good rate locked in for nearly four more years. As it turned out, their good deal was just an illusion.

Joseph, 77, and Marverine, 73, bought three five-year certificates of deposit from Bay Financial Savings Bank in Tampa last year. The CDs carried an interest rate of 6.86 percent, which worked out to a 7.10 percent annual yield. What the Cappiellos didn't realize was that their CDs could be redeemed early, at Bay Financial's discretion.

This month, the savings bank gave them the bad news:

"We have reduced our lending volume, and accordingly, desire to reduce the number of certificates of deposits at our institution," president Ronald Young wrote. "As such, we are contemplating exercising the optional redemption clause on your account in the near future, which allows us to recall your CD."

The bank gave the Cappiellos an option: Instead of being cashed out, they could trade their CDs in for new ones at 5 percent interest. But even the new CDs could be called any time after six months. For people such as the Cappiellos who have large CDs, the difference in the two rates could amount to a cut in income of several thousand dollars a year.

The Cappiellos were shocked.

"We were never told it was that type of CD or we would never have taken it," Mrs. Cappiello said. "I don't think it's fair."

Callable CDs like the one the Cappiellos bought have been controversial because they are poorly understood and often misrepresented. Retirees are attracted to them because their yields usually are a little higher than those on garden-variety CDs of comparable maturities.

What investors often fail to understand is that the call provisions always work in the bank's favor. If interest rates rise, the CD will not be called and the investor will face a substantial penalty to get out before the maturity date, which sometimes is more than 10 years away. But if interest rates fall, as they have this year, the bank can redeem the CD early and the investor is stuck having to reinvest the money at lower rates.

"This is the environment in which callable CDs will get called," analyst Greg McBride said.

The Cappiellos said they knew to watch out for callable CDs because they previously had a problem with one they bought through a broker. But the CD contract with Bay Financial doesn't use the word "callable." Instead, the call terms are spelled out in small print in the "optional redemption section." It says Bay Financial can redeem the CD with 90 days' written notice by paying the face value and a premium equal to 90 days' interest.

The Cappiellos say they never realized the contract provision was there. They say they have been buying CDs for 40 years and doing business with Bay Financial for a decade.

"I think I'm buying regular CDs like it's a bank, not a brokerage firm," Cappiello said. "They (now) claim they only sell callable, not regular CDs. They should have told me when I went there to ask them about the rate."

He said he will not leave his money at Bay Financial if his CDs are redeemed. Cappiello said he is inclined to opt for a short-term CD rather than locking in a lower rate for the long term. That means instead of a 7.1 percent annual yield, the Cappiellos probably will end up getting a yield of 3 to 4 percent on their money.

Bay Financial did not respond to repeated calls from the St. Petersburg Times.

Most of the controversy surrounding callable CDs has involved those sold by brokerage firms as "noncallable for one year," but with maturity dates 10 to 30 years away. Retirees have been complaining to the Securities and Exchange Commission that they thought they were buying one-year CDs but ended up with investments that won't mature during their expected lifetimes. Investors who need to cash in before the maturity date may face substantial losses.

The problem is serious enough that the Florida Department of Banking ranks callable CDs No. 2 on its list of "top five investment scams."

When callable CDs are explained to people, most are not interested in buying one, according to a consumer study by Synergistics Corp., a market research company in Atlanta. Last year the company surveyed households with incomes of $25,000 or more to gather opinions about various types of CDs. Only 9 percent rated as "very valuable" a one-year callable CD with an interest rate one percentage point higher than other CDs.

Some brokerage firms and banks have stopped selling the CDs. Among them is Providian Financial, which dropped the product this year for lack of customer interest. However, others, including BankAtlantic, continue to offer them.

"A lot of our customers actually like them," BankAtlantic spokesman Leo Hinkley said. He said the Fort Lauderdale bank has offered the CDs since 1995, and has called many of them in the past 11/2 years. Hinkley said customers are willing to accept the possibility of early redemption in exchange for a higher yield as long as they hold the CD.

As usual, the best advice to consumers: Ask questions and read the fine print.

"You've got to read and understand that account agreement," SEC spokesman John Nester said. "That's where all the things are spelled out."

-- Helen Huntley can be reached at or (727) 893-8230.

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