And what is being “called” mean, anyway?
As discussed in a recent post, with interest rates in these inflationary days higher than average, I have purchased some brokered bank CDs.
What is a Brokered CD?
These are regular FDIC-insured bank CDs which I purchased in my account at a stock broker. There are a few reasons I bought them through a broker, rather than directly from a bank.
Firstly, brokered CDs often pay somewhat higher interest rates compared to buying directly from a bank. Secondly, with brokered CDs I have a choice of CDs from various banks instead of needing to approach each bank directly. I also like the convenience of having these CDs in one place.
Call me Callable, or Not
CDs are bonds. When a bond is issued, the bond can either be callable or non-callable. A callable bond is one that can be redeemed before the original maturity date. if the issuer (the bank that issued the bond) so decides.
A non-callable bond is one that the issuer agrees not to redeem it before maturity.
For bank CDs, I usually purchase non-callable, but occasionally buy callable.
I my situation, I had purchased a six-month CD, but recently received notice that the bank is calling the CD at three months.
This means I will receive my principal back and accumulated three-monh interest on the call date.
At that time I will have a choice what to do with the money received.
My choices include buying a new CD at the then interest rate. Or invest the funds in something else. Or keep the funds, or spend it.
Meaning
Let’s think about why a bank would call a CD. When interest rate rise, we know that bond prices decline. And when interest rate decline, bond prices rise.
In this situation, when a bond is called, it relieves the bank of needing to pay interest for the remainder of the term. Namely, since the CD is called at three months, the bank will no longer need to pay the interest it would normally have had to pay for the remaining three month of the original six month maturity.
When we think of how a bank works… we consider that a bank lends money at a certain interest rate and borrows at a different interest rate. If the interest rate it lends money at is higher than the interest it pays when it borrows, then it makes a profit.
Conversely, if the interest it pays when borrowing is higher than the interest it can lend money, it suffers a loss.
Since banks and borrowers and lenders are all price sensitive, the bank must stay attuned to the fluctuations of interest rates and consumer sentiments.
Therefore, the calling of the CD indicates to me that this particular bank has determined that it considers the current interest rate of the CD to be higher than it wants to pay. Assumedly, it feels interest rate on what it can lend cannot sustain at the current level, and possibly the rates could even decline.
What does this say about the future of interest rates?
It is possible that this particular bank thinks inflation will tame, and interest rate hikes are less likely, at least in the short run. Time will tell. Banks can be wrong too. However, this does not indicate anything about the broader economy. I suspect a full accounting of banks calling callable bonds and CDs would be a stronger indicator of the direction of interest rates.
Have your CDs been called? Let me know here.
“Coney Island at Night” is a short silent, black and white film made by Thomas Edison in 1905. Courtesy Library of Congress.
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